Are toilets and bank accounts connected? In India, yes

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Indian residents leave a public toilet block in New Delhi on Aug. 16, 2014. Indian residents leave a public toilet block in New Delhi on Aug. 16, 2014.
Prime Minister Narendra Modi’s plan to develop India includes creating toilet access for all 1.2 billion people and opening a bank account for every adult who doesn’t already have one. India’s state-owned lenders are being called on to do both, threatening to erode profits and add expenditures at firms saddled with nonperforming loans.
Modi has asked banks to open branches within 5 kilometers (3 miles) of all of India’s 664,000 villages in order to reach 75 million households that have no access to formal financial services. After he announced on Aug. 15 a mission to build toilets in public schools, the Finance Ministry sent a memo to state-owned lenders urging them to pay for construction, according to a senior banking executive who saw it and didn’t want to be identified as the communication wasn’t public.
Banks have committed 740 million rupees ($12 million) to the toilet-building efforts, using funds for tax-advantaged corporate social responsibility projects, according to G.S. Sandhu, banking secretary at India’s Finance Ministry. They also registered 50 million new account holders and collected 35 billion rupees in deposits using temporary kiosks in villages and enlisting rural shop owners as representatives, he said.

A new banking customer fills up a form to open a bank account at an Oriental Bank of Commerce branch in Mumbai on Aug. 22, 2014.
“The announced financial-inclusion mission will be a drag on profitability of the government-controlled banks in the short-to-medium term,” Vibha Batra, the New Delhi-based head of financial-industry ratings at ICRA Ltd., the local unit of Moody’s Investors Service, said in an interview. “The lenders’ ability to recover the costs from these marginal customers through fee-based initiatives and low-cost savings deposits remains to be proven.”
Marginal customers
The cost of delivering services to marginal customers, defined as those lacking access to the banking industry, is as much as 10 times to 12 times the revenue potential, according to a 2011 Boston Consulting Group report. Profitability as measured by return on assets at India’s 26 state-run lenders may fall further from the lowest level in at least 12 years as they bring unbanked households into the system, according to Moody’s, which didn’t provide an estimate.
Raghuram Rajan, governor of the Reserve Bank of India, called attention to the matter in a Sept. 15 speech in Mumbai.
“The public-sector banks are there to undertake social actions when necessary, but those mandates should be backed by financial gains,” he said. “After all, public-sector banks also have private shareholders and are not any longer an extension of the government. They should be seen as independent entities.”
Toilet construction
IDBI Bank Ltd. (IDBI), based in Mumbai, and Indian Overseas Bank (IOB) in Chennai announced plans to build boys’ and girls’ facilities in 359 schools near their branches. IDBI said it would spend 90 million rupees, while IOB didn’t disclose its budget.
D.S. Malik, a Finance Ministry spokesman, declined to comment on the memo asking for banks’ participation in the toilet-construction program, which is designed to combat a sanitation problem that costs India an estimated 600,000 lives annually from diarrhea and exposes a third of the women to the risk of rape or sexual assault.
Nonperforming loans at Indian banks were 4 percent of the total as of March 31, down from 4.2 percent in September 2013, the highest level since 2006. At IDBI, they increased 1.3 percentage points to 5.6 percent of the total in the 12 months ended June 30 compared with the same period a year earlier. Return on equity, a gauge of profitability, fell to a third of what it was the previous year.
Return on equity at all Indian lenders dropped to 9.6 percent as of March 31, the lowest since at least 2002, the Reserve Bank of India said in June.
‘Irregular earnings’
“The upfront cost of extending basic financial services to the unbanked is relatively high, as the targeted demography is a predominantly rural population,” Anjalika Bardalai, London-based analyst at Eurasia Group, said in a phone interview before leaving the consulting firm on Sept. 26. “The low and irregular earnings of many in this demographic subset will hamper bank profitability even in the medium term.”
About half of India’s villages have access to banking services, according to central bank estimates. An estimated 65 percent of Indian adults don’t have bank accounts, World Bank data from 2011 showed.
Banking correspondents
In addition to setting up kiosks, banks also have been relying on a program started by the central bank in 2006 that allows them to outsource deposit collecting and basic banking services to traders, shopkeepers and small-business owners across the country.
More than 200,000 so-called banking correspondents had signed up as of March 2013, according to the latest central bank data available. Modi said in August they would be guaranteed a minimum of 5,000 rupees a month in compensation by the banks.
“In the long run, this financial-inclusion drive will help the lenders to grow a steady low-cost deposit base,” said Vishal Narnolia, Mumbai-based analyst at SMC Global Securities Ltd. “But for at least next few years, the cost of maintaining the accounts for the poor, rural population will be way higher than the revenue potential.”
 At State Bank of India, the country’s largest lender, Chairman Arundhati Bhattacharya said banks were geared up.
“The use of debit cards will allow the unbanked to start building a transaction history, which can be a decisive step in initiating them toward financial inclusion,” Bhattacharya wrote in an e-mail. “This will also help the banks for better product designing and targeting.”
Bhattacharya has said in the past that politicians should stop making decisions that favor voters over banks, such as forgiving farm loans and fostering a culture of nonpayment. SBI hasn’t announced plans to participate in the toilet program.
Wealth gap
Providing banking services and protecting the earnings of India’s poor may help narrow the country’s wealth gap. In rural India, 5 percent of households owned 36 percent of assets, according to the government’s 2011 Human Development Report. The World Bank estimates that more than two-thirds of the nation’s population lives on less than $2 a day.
“Universal financial access is a national priority, as once every household is connected to the financial system, there will be increased financial savings,” Rajan said in Mumbai. “Through direct benefits and subsidies transfer there will be less leakage, less price distortion and more empowerment.”
Tight deadline
Connecting the entire population to bank branches and using electronic payments to deliver government subsidies could help eradicate losses of about 1 trillion rupees a year and reduce corruption that accounts for as much as 80 percent of total waste from the subsidy system, according to a 2010 report by McKinsey & Co.
Banks will have to provide a credit line of 5,000 rupees to account holders at an interest rate of 12 percent or lower, according to Modi’s plan. Money lenders typically charge more than 36 percent, said SMC Global’s Narnolia.
The government also is seeking to use the banks to provide free accident insurance worth 100,000 rupees and life insurance of 30,000 rupees. The lenders may consider providing the service through the nation’s 155,000 post offices, according to an Aug. 22 Finance Ministry statement.
Modi has set Jan. 26 as the deadline for lenders to provide access to banking services, insurance coverage and a debit card to all Indian households.
“The tight deadline for this scheme has diverted the attention of the banking system from recovery of bad loans,” said Narnolia. “This could add to the soured-debt woes.”
By August 2018, if banks determine it’s profitable, they will have to set up “full-fledged brick-and-mortar” branches in as many as 74,000 villages with populations of more than 2,000 people, the Finance Ministry said, leaving the final decision to the banks.
“As the targeted population has low income and irregular earnings, the risk of default is obviously higher,” Narnolia said. “We can only hope that banks will be able to navigate this patch with minimal damage.”

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