Financial Inclusion: A Success Story with Hidden Gaps

India’s financial inclusion programme has been one of the biggest public policy successes in recent decades. Since the launch of initiatives like the Pradhan Mantri Jan Dhan Yojana (PMJDY) in 2014, the percentage of Indians with bank accounts has soared to around 96%, according to official estimates.

Millions of households that had never interacted with formal banking now have access to:

• Savings accounts.

• Digital payments.

• Government transfers directly into their bank accounts.

This remarkable leap has transformed the way people store money and receive benefits, curbing leakages and reducing the need to hold cash at home.

The Other Side of the Story: Credit Exclusion Persists

However, recent data and expert analyses highlight a less-celebrated truth: access to credit—especially affordable, formal credit—remains severely limited for India’s poor and low-income households.

While bank accounts are widespread, poor families still struggle to get loans from banks or formal NBFCs. Instead, they often fall back on informal money lenders who charge exorbitant interest rates.

This paradox exposes a deep flaw in India’s financial inclusion story:

Inclusion on the liability side (deposits) is strong, but on the asset side (credit), it is weak.

Why Do the Poor Rely on Money Lenders?

Despite having bank accounts, poor households often cannot meet formal lenders’ requirements, such as:

• Collateral.

• Stable income proof.

• Credit history.

• Proper documentation.

Money lenders, on the other hand:

• Offer quick cash with minimal paperwork.

• Understand the local borrower’s reputation and needs.

• Have flexible repayment terms (albeit costly).

These factors make them attractive, despite the exploitative interest rates, which can exceed 30-50% annually or even more.

The Role of Microfinance: A Bridge or a Risk?

Microfinance institutions (MFIs) were supposed to be the answer—a formal system tailored for low-income borrowers, with:

• Small loans.

• Group lending models to mitigate risk.

• Financial literacy initiatives.

But new data show rising defaults in the microfinance sector:

• Default rates are increasing among microfinance loans, indicating stress in borrower segments.

• MFIs often serve the same populations that also borrow from informal money lenders, making them a proxy for non-institutional credit.

This trend suggests a worrying overlap where households:

• Take multiple loans (formal and informal) to manage cash flows.

• Fall into debt traps when earnings falter.

Expert Views: The Inclusion That Isn’t

Debopam Chaudhuri, Chief Economist at Piramal Enterprises, summarised the problem bluntly:

“Despite the smooth and good progress we have seen in financial inclusion, progress has been limited to the liability side of lenders, which is the opening of deposits.”

In other words:

• People can save money in banks.

• But they cannot easily borrow from them.

This imbalance hurts the poor:

• Limits entrepreneurial activity (they can’t get cheap loans to expand businesses).

• Forces them to pay high interest to informal lenders.

• Worsens financial stress during emergencies.

Data-Backed Concerns

Recent data show:

• The incidence of loan defaults is rising in microfinance.

• Many low-income families are over-leveraged, juggling multiple loans.

• Borrowing from informal money lenders is increasing, despite bank account penetration.

This points to systemic issues in India’s credit delivery to the bottom of the pyramid.

Why Formal Credit Access Remains Tough

1. Risk Aversion Among Banks and NBFCs:

• Fear of defaults makes lenders cautious.

• Preference for secured, larger, and urban borrowers.

2. Documentation Gaps:

• Many poor people lack clear income proof.

• Difficulty in proving creditworthiness.

3. High Transaction Costs:

• Serving remote or rural areas is expensive.

• Small-ticket loans are less profitable for banks.

4. Regulatory Constraints:

• Strict KYC norms, while necessary, create barriers.

• Lending caps for MFIs limit flexibility.

Informal Lending: Easy But Costly

Money lenders continue to thrive because:

• They are embedded in communities.

• Offer flexible terms.

• Require no collateral or paperwork.

But the cost is punishing:

• High interest rates drain incomes.

• Debt cycles trap families for years.

Policy Efforts and Gaps

Government initiatives have tried to address these issues:

• PM Mudra Yojana offers collateral-free loans.

• Self-Help Groups (SHGs) link women to bank credit.

• Jan Dhan accounts improve banking reach.

But challenges persist:

• Mudra loans often too small for meaningful investments.

• SHGs work unevenly across states.

• Many beneficiaries still prefer informal lenders for speed and flexibility.

Rising Defaults: A Warning Sign

The increase in microfinance loan defaults is especially troubling:

• It suggests stress among borrowers, many of whom also use money lenders.

• MFIs have faced criticism for aggressive lending and recovery practices.

• Borrowers take multiple loans to repay older debts—a classic debt trap.

The Bigger Economic Impact

Heavy reliance on informal credit has macro-level consequences:

• High interest payments reduce disposable income.

• Limits productive investment in small businesses.

• Financial stress leads to poorer health, education outcomes.

• Undermines overall economic growth.

Towards True Financial Inclusion

Financial inclusion must go beyond opening bank accounts. True inclusion means:

• Access to affordable credit.

• Insurance for shocks.

• Savings instruments that deliver real returns.

• Financial literacy so people understand costs and risks.

Experts argue for:

• Better credit scoring using alternative data (utility bills, mobile usage).

• Fintech solutions to reduce costs and improve reach.

• Stronger borrower protections to prevent over-indebtedness.

Conclusion: Bridging the Credit Divide

India’s achievement in bank account penetration is real and worth celebrating. But it risks becoming meaningless if the poor cannot access credit when they need it.

Money lenders fill this gap but at a painful cost. Rising microfinance defaults show that even formal solutions are under strain.

Policy makers, banks, and MFIs need to reimagine financial inclusion as a comprehensive system:

• Deposits plus credit.

• Education plus access.

• Technology plus trust.

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Only then can India’s poorest households truly benefit from being financially included—not just on paper, but in real life.