Ubiquitous Access to Payments – One (big) Step Forward

By Bindu Ananth

Yesterday, the RBI announced in-principle Payment Bank licenses for eleven applicants. To put things in perspective, there were two new bank licenses in the last decade. The successful applicants include the largest telcos, corporate houses, Business Correspondents, a Depository and a mobile wallet provider. The number of licenses and the diversity of the pool bode well for the scale and scope of what will be pursued by this new category of banks in the years to come.

While previous licensing rounds were always for “full-service” banks, this represents the first round of licensing for a differentiated banking design following on RBI’s Discussion Paper on Differentiated Banking and the recommendations of the Committee on Comprehensive Financial Services for Small Business and Low-Income Households. To recap, a Payment Bank can provide deposit and payment products but cannot lend. This very important design feature has an important implication from a regulatory perspective – Payment Bank promoters now cannot “cross the floor” in terms of raising public deposits and lending these out. Therefore, the implications of “fit and proper” are now quite different for this group of promoters. This perhaps explains why this round produced eleven licenses against two in the last decade. And at this stage of development of the Indian banking sector, these eleven new entrants could be just what the doctor ordered for innovations on savings and payment services while not adversely impacting the stability of the banking system. An IFMR Finance Foundation working paper reported that the asset portfolio of the average rural household in India is composed almost entirely of two physical assets—housing and jewellery with little to no financial assets of any type.

Also from a financial system design perspective, this is a timely acknowledgement that the credit and payments strategy must evolve differentially within the broader financial inclusion strategy. While progress on credit would necessarily have to be much more measured and prudent no matter what strategies are adopted given the inherent risks and customer protection concerns, there is an urgent need to make access to payments ubiquitous. Yesterday’s announcement is an important step forward in that direction.


From the hills of Uttarakhand

By Kshama Fernandes, CEO, IFMR Capital

I am writing from Thatyur village in Theri district, Jaunour block – about 3.5 hours north of Dehradun in Uttarakhand, India.

I met Akhilesh Badhani today, an entrepreneur in a beautiful riverside village in a valley surrounded by hills. He started the hardware and provisions shop 4-5 years ago and caters to around 25 to 30 villages in the surrounding hills having a total population of around 10,000. He is a client of Sahastradhara KGFS, has availed a Micro Enterprise Loan of Rs. 1.5 lakh from them and is one of their most disciplined borrowers. He has almost repaid his first loan and wants to now apply for a larger one.

Thatyur village
View of the Thatyur village

At some stage Akhilesh decided to pursue his studies at Benaras Hindu University and so his younger brother runs the shop for him now. Akhilesh did a one-year course in Sanskrit from an institute in Rishikesh. Then did his Masters in Indian philosophy from BHU and is currently pursuing a Ph.D in Bhagwat at BHU (there are two streams of Indian philosophy –  Bhagwat and Vedanta). He aspires to be a professor of Indian philosophy post completion of his research.  Said he wants to work on dispelling the superstition associated around Indian scriptures.

Here is what he explained to us from a scripture: Imagine a devotee who makes an offering of ghee, kheer and all festive delicacies to the Lord in a temple. And standing right next to him is a poor starving man who hasn’t eaten for days. Does the offering of ghee made to the Lord make any sense? Such offering is akin to bhasma (ashes) left behind by a fire – worthless. Feed the hungry man instead and it will be worth its weight in gold.

Akhikesh concluded by saying “Nar seva hi Narayan seva hai” which inadequately translates into “Service to man is service to God”.

To-be-Dr Akhilesh
To be Dr. Akhilesh

I was fortunate to meet Akhilesh because he was visiting his village for a week during University vacations. He returns back to the city in pursuit of his research on the 23rd.

Everytime I visit the field I am struck by how many fascinating stories exist out there. A few we have the opportunity to touch – we provide them with a financial product and they provide us with the inspiration to go on and touch many others.


IFMR Holdings partners with Accion, LeapFrog and Lok Capital to scale up our financial inclusion platform

Our mission to “ensure that every individual and every enterprise has complete access to financial services” took a significant step forward with an equity investment of US$ 25 million in IFMR Holdings by Accion, a financial inclusion pioneer, LeapFrog Investments, a specialist investor in emerging-market financial services, and Lok Capital, an Indian impact investment firm. IFMR Trust is the promoter and remains the majority shareholder of the company.

The investment allows IFMR Holdings to accelerate its efforts to ensure financial access to the remotest corners of the country. Towards this IFMR Holdings already serves millions of financially excluded households and enterprises through three businesses: IFMR Capital – a debt capital markets platform for 75 originators offering micro-loans, small business finance, affordable housing and commercial vehicles finance, and reaching over 15 million financially excluded people; IFMR Rural Finance – a technology licensor that developed the Kshetriya Gramin Financial Services (KGFS) model for remote rural markets; and IFMR Rural Channels – a credit, insurance and pensions provider to over 600,000 clients through 242 branches in rural areas.

In a country where 86% of Indians do not borrow from a formal source, only one out of every two Indians has a savings account, and insurance penetration is barely 4%, the task ahead is vastly challenging and one which, IFMR Holdings and its partners, are ideally placed to overcome. 

Commenting on the transaction, Bindu Ananth, Chair of IFMR Trust, the promoters of IFMR Holdings, said, “This comes at an important inflection point for IFMR Holdings. Against the backdrop of a very favourable policy environment for financial inclusion, we are accelerating growth across all our businesses. We intend being at the forefront of business models combining scale and high-quality financial services for many millions of Indians.” 

IFMR Holdings CEO, Sucharita Mukherjee said, “Our belief is that access to finance, supported by well-functioning markets, is critically important for low-income households. This exciting partnership with like-minded investors such as Accion, LeapFrog and Lok brings the benefit of international best practice and a wide range of global insights to this work in India.

 To read the press release click here.


Measures of Financial Depth and their Limitations

By Nishanth K & Irene Baby, IFMR Finance Foundation

In the previous post of the blog series on financial depth, we attempted to understand the nature of the relationship between financial depth and economic growth. The natural question that follows is how to measure financial depth. This post answers that question by:

  1. Introducing various measures of financial depth
  2. Discussing the limitations of these conventionally used measures

Measures of Financial Depth

Early literature used the ratio of total bank credit to Gross Domestic Product (henceforth GDP) as the indicator of financial depth[1]. However, private firms are more likely to stimulate growth through their risk evaluation and corporate control capacities than credit to the government or state-owned enterprises[2]. Hence, ratio of domestic credit lent to the private sector to GDP has now emerged as the most commonly used indicator of financial depth of an economy. The private credit, therefore, excludes credit issued to governments, government agencies, and public enterprises. It also excludes credit issued by central banks[3].

A recent research paper by the IMF outlines the various measures of financial depth[4]:


However, in the context of developing countries, it is reasonable to assume that pension fund, mutual fund and insurance markets are not adequately developed to be used as measures of financial depth. Therefore, private-sector credit-to-GDP has remained the most widely used measure of financial depth.

Limitations of a Credit-to-GDP Ratio as a measure of Financial Depth

The above discussed measures are not without their limitations. This section discusses why these measures are inadequate to understand excessive provision of credit within an economy. Given below are the major limitations[5]:

1) Ignores heterogeneity in credit demand across countries: These measures ignore that the demand for credit across countries varies with their levels of economic, financial and institutional development. The main drivers of this heterogeneity in demand across countries are differences in financial depth, access to financial services, use of capital markets, efficiency and funding of domestic banks, central bank independence, the degree of supervisory integration, and experience of a financial crisis.


Figure 1: Bank Credit Can be a Misleading Measure of Financial Depth and Access – Korea and Vietnam have similar values of banking depth—a private credit to GDP ratio. However, they differ, by a large amount, in terms of access. The use of banking accounts is virtually universal in Korea, but in Vietnam only one-quarter of adults have a bank account.[6]

2) Assumes unit-elastic relationship between credit demand and income (as proxied by GDP) and price (as proxied by GDP Deflator): Depth indicators assume that a one-percent increase in GDP or the GDP Deflator results in a corresponding one-percent increase in the demand for credit. This assumption is violated, particularly for developing countries because of the varying usage of credit in economic transactions due to different levels of development.

3) Assumes that financial depth variables are stationary: A stationary variable is one whose statistical properties such as mean, variance and autocorrelation are constant over time. Credit-to-GDP ratio is empirically shown to be a trending variable, which means that credit grows considerably faster than the nominal GDP.

4) Fails to capture the effect of financial deepening at the sub-national levels: As conventionally used measures are constructed using readily available macroeconomic data, they are reflective of macroeconomic outcomes in financial deepening. In other words, they do not necessarily capture how well finance accomplishes various functions at various levels of the economy.

Consider the case of measuring financial depth in India where depth of financial services varies significantly amongst different regions. Ideally, the value of INR 1 of credit in a credit starved district should be greater than its value in a district which is relatively well-penetrated by credit. Inclusix published by CRISIL, which is an objectively measured index of financial inclusion provides a score for every district (out of 100), with 100 indicating a fully financially included district.[7] Scores in the index range from 96.2 for Pattanamthitta district in Kerala to a low of 5.5 for Kurung Kumey district in Arunachal Pradesh. This suggests that there is an inherent need for accounting for sub-national variations for one to appropriately measure the level of financial depth in an economy[8].

One measure of financial depth that does away with the limitations of conventional measures discussed above is ‘Equilibrium Credit’[9]. It is an important concept because it helps identify both excessive and deficient credit provision at sub-national levels of the economy. In other words, equilibrium credit helps to identify benchmarks against which the credit provision in various levels of the economy is judged to be excess or not. The next post in the series will discuss the idea of equilibrium credit in detail.

[1] King and Levine 1993. Finance and Growth: Schumpeter Might Be Right

[2] Ibid

[3] Global Financial Development Report: Key Terms Explained. 2012. http://go.worldbank.org/E9RQKCP9J0

[4] Sahay et al. 2015. Rethinking Financial Deepening: Stability and Growth in Emerging Markets

[5] Buncic and Melecky. 2014. Equilibrium Credit: The Reference Point for Macroprudential Supervisors

[6] Sahay et al. 2015. Rethinking Financial Deepening: Stability and Growth in Emerging Markets

[7]Report, Committee on Comprehensive Financial Services for Small Businesses and Low Income Households. 2014, submitted to Reserve Bank of India. https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/CFS070114RFL.pdf

[8] ibid

[9] Same as footnote 3


Relationship Between Financial Depth and Economic Growth

By Nishanth K & Irene Baby, IFMR Finance Foundation

This is the first post in our blog series on the concept of financial depth and the various methods to measure it. The introductory post summarizes the literature pertaining to the significance of financial depth. The subsequent posts in the series covers the limitations of the various measures of financial depth and delves on the concepts of Equilibrium Credit and Financial Possibility Frontier. The series will also cover the advantages of these concepts over previously-used measures, especially when attempting to measure financial depth at sub-national levels.

The relationship between financial development and economic growth has been long discussed and debated. The earliest school of thought led by Joseph Schumpeter[1] posited the idea that countries with well-developed financial systems tend to grow faster than the rest. However, recent studies suggest that unrestrained and unchecked use of financial instruments and practices has led to macroeconomic crises[2].

In the context of this blog series, financial development is to be broadly understood as a multidimensional concept that includes measures of depth, access, efficiency[3] and stability[4]. Financial depth refers to the size of financial institutions and markets. It is captured by measures such as credit-to–GDP ratio, pension fund assets-to-GDP ratio as well as mutual fund assets-to-GDP ratio. Access is the degree to which individuals can and do use financial institutions and markets. Efficiency is understood as the efficiency of financial institutions and markets in providing financial services. Stability refers to the stability of financial institutions and markets as captured through growth volatility.

Within these broad measures for financial development, we undertook a review of literature to further our understanding of approaches that focus on ‘Credit Depth’ (Credit-to-GDP ratio) as a measure of financial depth, as well as its relationship with economic growth, inequality and poverty. This post summarises our key findings from the literature survey.

Financial depth is positively correlated with economic growth across countries

Joseph Schumpeter[5] (1912) postulated that financial development drives technological innovation and consequently, the rate of economic growth. Also, recent empirical economic evidence across a cross-section of 80 countries over the time period 1960-1989 shows that higher levels of financial development are significantly and robustly correlated with faster current and future rates of economic growth, physical capital accumulation, and economic efficiency improvements[6]. In other words, when countries have relatively high levels of financial development, economic growth tends to be relatively fast over the next 10 to 30 years[7].

Financial depth influences growth rates of sectors within a country

Industries that are more dependent on external finance (defined as the difference between investments and cash generated from operations) grow disproportionately faster in countries with a more developed financial sector[8]. For example, in Malaysia, which has high levels of financial depth, the Drugs and Pharmaceutical industry (which is relatively heavily dependent on external finance) grows at a 4% higher annual real rate than Tobacco (which is relatively less dependent on external finance). In Chile, which was in the lowest quartile, drugs grew at a rate of 2.5% lower than Tobacco.

In India, expansion of directed credit lending (from 1998 – 2002) to medium-sized firms (firms with requirement for capital stock between INR 6.5 to 10 million) shows that this increased availability of credit accelerates their rate of growth of sales, and consequently, profits[9].

Financial deepening reduces poverty and inequality

Research shows that financial deepening significantly raises the average income of the lower 80% of the population of the world and lowers inequality across 70 middle and low income countries[10]. Empirical research also shows that with every 0.1% increase in the level of credit available in an economy, head count poverty ratio reduces by 2.5% – 3%[11].

The positive impact of financial deepening on reducing poverty holds for within-country studies too. Empirical studies show that financial depth has a negative and significant impact on rural poverty (head- count ratio and poverty gap) in India[12]. Financial deepening works positively towards reducing poverty by increasing opportunities for entrepreneurship in rural areas and enabling migration from rural to urban areas[13].

Financial depth, beyond a threshold, leads to adverse macroeconomic effects


A deeper financial system is significantly associated with lesser growth volatility; however, the relationship appears to be nonlinear. As the financial system becomes larger relative to GDP, systemic risk becomes relatively more important, and acts to reduce stability. In other words, when there is excess credit within an economy, there can be a “vanishing effect” of financial depth on economic growth. The threshold above which this vanishing effect occurs is estimated to be when private credit goes beyond 110% – 120% of Gross Domestic Product (GDP)[14].


Figure 1: Replicated from the results from table 5 of Arcand et al(2012). The grey line shows that as credit to GDP ratio goes beyond 1.1, the slope of the graph becomes negative.

Having discussed the significance of financial depth on the macro-economy, the next question that naturally follows is regarding the ways to measure financial depth. The next blog post in this series will briefly discuss the various measures used in literature and their limitations.

[1] Levine, 1997. “Financial Development and Economic Growth: Views and Agenda” 
[2] Loayza and Ranciere, 2006. “Financial Development, Financial Fragility, and Growth” 
[3] Sahay et al, 2015. “Rethinking Financial Deepening: Stability and Growth in Emerging Markets”
[4] Čihák, Demirgüč-Kunt, Feyen and Levine, 2013. “Financial Development in 205 Economies, 1960 to 2010″ 
[5] King and Levine, 1993. “Finance and Growth: Schumpeter Might Be Right” 
[6] ibid
[7] ibid
[8] Rajan and Zingales, 1998. “Financial Dependence and Growth.”
[9] Banerjee and Duflo, 2012. “Do Firms Want to Borrow More? Testing Credit Constraints using a Directed Lending Program
[10] Honohan, 2004. “Financial development, growth, and poverty: how close are the links?”
[11] ibid
[12] Ayyagari, Beck and Hoseini, 2013. “Finance and Poverty: Evidence from India
[13] ibid
[14] Berkes, Panizza and Arcand, 2012. “Too Much Finance?”