1

CHAPTER-II

REVIEW OF LITERATURE

Having observed the pertinent need for rural credit of RRBs in

India, an attempt is made to review the existing literature on RRBs in this

chapter.

Authentic and systemic studies carried out in Andhra Pradesh on the

performance of the regional rural banks are scanty, although such studies are

immense in the rest of the country. Now, an attempt is made to review the

major studies on the regional rural banks on the hope that it would throw

useful insights into our enquiry.

The working group1 on multi-agency approach in agricultural finance

(1976) recommended that regional rural banks are to be preferred because

they are better suited to direct financing of farmers. The committee2 set up

by the reserve bank of India in June 1977 to review the working of regional

rural banks came to the conclusion that within a short span of two years,

they have demonstrated their capability to serve the purpose for which they

were established. Therefore, the program for the establishment of more

1 Reserve Bank of India, Working Group on Multi-Agency Approach in Agricultural Finance (Karnak Working Group)Mumbai, 1976. p.87.2 Reserve Bank of India, Report of the Review Committee on Regional Rural Banks (Dantwala Committee) NewDelhi, 1978, pp 89-93.

2

regional rural banks deserves to be accelerated. The committee on regional

rural banks constituted by the reserve bank of India conducted a study on the

viability of regional rural banks (1979). It revealed that it was not possible

for all branches to become viable because some branches were located at

centers where the potential had been limited. Some branches could not

expand their business because of keen competition from branches of

commercial and co-operative banks.

Studies Conducted in Different States

Soudamini Nagar (1979)3 in a study on regional rural banks (in

Rajasthan) found that the regional rural banks had made creditable progress

in deposit mobilization and credit distribution.

Mohana Rao (1980)4 in his study on regional rural banks in Andhra

Pradesh concluded that, given the coverage, the bank was functioning well

in meeting the credit requirements of the target group.

3 Soudamani Nagar, “Regional Rural Banks: Rajasthan Experience”, Eastern Economist, 72 (24), June 15, 1979, NewDelhi, pp 81-83.

4 Mohana Rao, L.K. "Impact of Programmes on Target Groups-Case Study of Regional Rural Banks", Indian Journal ofAgricultural Economics, Vol. XXV, No.4, October-December, 1980, New Delhi, pp73-77.

3

C.D. Wadhava (1980)5 conducted a case study of two regional rural

banks working in Haryana and Rajasthan in 1977. It found that regional rural

banks inherited complicated procedural formalities from their sponsor banks

and also the regional rural banks were not able to meet the targeted

disbursement of credit set by the government of India. The study attributed

limited scope of direct lending by regional rural banks in the areas of

operation, absence of effective links with primary co-operative societies and

farmers service societies and lack of adequate support from the government

for expanding business resulted in the setting-up of regional rural banks.

Inu Jain (1980)6, Reddy and Suresh Kumar (1982)7 in their studies

came to the conclusions that, weaker sections like small and marginal

farmers and agricultural labourers had got the major share of credit from the

bank.

With a view to making a qualitative assessment of the performance of

5Wadhva, C.D, "Rural Banks for Rural Development, Mac Millan Company of India Ltd, 1980, New Delhi, pp 176.

6 Inu Jain, “Rural Credit and Regional Rural Banks” Khadi Gramodhyog, 28(3), June 1980, New Delhi, pp.3-5.

7 Reddy G.R. and Suresh, Kumar, D.V.”Regional Rural Banks and the Weaker Sections Uplift”, Land Bank Journal,20(3) 1982. New Delhi, pp 73-75.

4

regional rural banks, the reserve bank of India (1982)8 conducted a study in

respect of eleven banks. The report revealed that regional rural banks had

successfully maintained their image as a small man's bank by confining their

credit facilities to the target group. The national bank for agriculture and

rural development (NABARD)9 had commissioned a study on the viability

of regional rural banks and entrusted the same to the agricultural finance

corporation (1983-84). Though, the corporation submitted its report, it did

not offer any immediate solution to viability problems of these institutions.

The committee to review arrangements for institutional credit for

agriculture and rural development (CRAFICARD) (1982)10 examined the

role of regional rural banks in the rural credit system and recommended that,

as regional rural banks were more suitable for rural development work,

preference should be given to regional rural banks in regard to licensing of

branches in the rural areas. The committee also recommended that regional

rural banks should continue to confine their operations to the weaker

sections.

In another important study conducted by the agriculture finance

8 Reserve Bank of India, Report on Trend and Progress of Banking in India 1982, p.67.9 Ibid, p.69.

10 Reserve Bank of India, Report of the CRAFICARD, Mumbai ,January 1982, pp.78-80.

5

corporation11 in 1983, some more interesting facts have come to light.

Originally, the study was meant for comparative performance of two

regional rural banks, one in Karnataka and the other-in Andhra Pradesh. A

predesigned sample of beneficiaries from the selected branches was

approached to find out (a) quality of lending (b) payment, and (c) views of

the borrowers.

This study pointed out that the government departments and their

agencies should treat regional rural banks as their own institutions and

provide all possible help including policy protection and rural poor. In this

connection the study pointed out that frequent liaison with the authorities of

government projects and agencies will enable the regional rural banks to set-

up their lending levels and as far as possible encouraging group loans.

International Studies

Hossain (1984)12 conducted a study on grameena bank in Bangladesh,

which was started in 1976 as a pilot experiment and development project for

the landless in an area near Chittagong University. The research study

focuses attention on the socio-economic conditions of borrowers, use of loan

11 Agricultural Finance Corporation Limited, Regional Rural Banks, A Study of the Regional Rural Banks sponsoredby Syndicate Bank, The Author, 1983, Mumbai, p.65.

12 Hossain,M. "credit for the rural poor"-The Grameena Bank in Bangladesh, Research monograph, Bangladesh

Institute of Development Studies,Bangladesh, Monograph No.4.1984, pp 43-48.

6

and recovery performance. The findings indicate that the grameena bank has

made positive contributions to the alleviation of poverty in the area of its

operation.

All India Studies

The study by Abdul Noorbasha and Dakshina Murthy (1984)13 found

that regional rural banks had shown a tendency to grow and cater to the

needs of weaker sections. The study also found that regional rural banks

identify themselves as the perfect matching credit agents of the rural sector,

compared to the than that of the commercial banks. But this study is based

on secondary data only.

Lakshmi Narayana (1984)14 in a study on regional rural banks in West

Bengal found that the recovery work of overdue loans together with the

normal work of processing new credit proposals and enlisting new

borrowers hardly allowed the bank officials any time for guiding them in

adopting improved farming techniques and making better use of credit.

13 Abdul Noorbasha and Dakshina Murthy, D. Sulthan Chand Publishers, New Delhi, 1984 pp 43-47.

14 Lakshmi Narayana V. “Regional Rural Banks-Problems and Prospects A Case Study,” Financing Agriculture , 14(2),April-June, 1984, New Delhi, pp 54-56.

7

Singh and Upadhya (1984)15 conducted a study on the loan recovery

aspect of regional rural bank in Bihar. Crop failure, expenditure on marriage

and other social functions in the family were considered important factors of

non-payment of loans. Inadequate follow up measures and lack of serious

attitude of borrowers towards repayment were also explained as reasons.

While, Jagadish Prasad and Sunil Kumar (1985)16 in a study about regional

rural bank in Bihar found that, the loans given to the poor were generally

accepted as a dole or relief programme, which was pointed out as the main

reason for poor repayment.

Prasad (1985)17 in a study about Sri Visakha Grameena Bank in

Andhra Pradesh revealed that regional rural banks were catering to the needs

of rural society, creating banking consciousness, but also serving as corner

stone to the building of rural development.

A study by Nagi Reddy and Rathna Kumar (1986)18 found that low

yield, low market price for the produce, repayment of other debts and other

15 Singh P.K and Upadhya, K.M., “A study of Loan Recovery of Regional Rural Banks in Bihar” FinancingAgriculture, 16(2) April-June, 1984, New Delhi, pp.37-39.

16 Jagadish Prasad and Sunil Kumar, “Regional Rural Banks: A Study, “ Kurukshetra, 33(8), May 1985, New Delhi,

pp 31-33.

17 Prasad B.V.S, “Credit and Rural Bank: A Case Study: Published M.Phil, Disseratation Submitted to S.V.University,Thirupathi, 1985, pp.89-91.

18 Nagi Reddy and Ratna Kumar, "Credit Repayment Performance of Borrowers of Regional Rural Banks: A Case

8

domestic expenditure as the main reasons for non-repayment of loan. While,

better yield, desire to get future loans, persuasion by bank officials, etc. are

the main reasons for prompt repayment.

Rehman (1986)19 in his paper assessed the impact of the grameena

bank on the existing rural power structure of Bangladesh. The findings of the

study indicate that grameena bank members, being conscious of their status

as opposed to the rural elites, have already developed a countervailing force

to ensure their participation in the development process.

Balishter (1986)20 undertook a study to evaluate the performance of

the Jamuna gramin bank. On the basis of the working results of the bank, it

was concluded that, in the event of future expansion of rural banking, greater

importance should be given to the extension and strengthening of the

network of regional rural banks along with the expansion of branches of

commercial banks.

Another study by Rehman (1987)21 highlights the factors which have

contributed to the success of grameena bank, Bangladesh, in reaching the

Study", Southern Economist, July 1986, New Delhi, pp.15-17.19 Rehman, A. "Impact of Grameena Bank Intervention on the Rural Power Structure" , Research monograph,Bangladesh institute of development studies, No.61, Bangladesh, 1986, pp 76-79.

20 Balishter, et. al, “Performance of Regional Rural Banks” An evaluation of a Rural Bank in Agra District of UttarPradesh" Yojana,Vol.No.9 December 1986, New Delhi, pp 31-38.21 Rehman, A. " Alleviation of Rural Poverty: Replicability of Grameen Bank Model" Grameena Bank EvaluationProject, Agriculture and Rural Development Studies, Economic and Political Weekly, Vol.7, November,1987. pp.29-34.

9

poor through an innovative credit program. The design of the program,

targeting the rural poor and women as clients, excellent implementation

system, decentralized and participative management style and various other

innovative polities were cited as the factors responsible for its success.

An in-depth household survey in five project villages and two control

villages found that grameena bank members had incomes about 43 per cent

higher than the non-participants in the adopted for project work villages.

This effect on the income was attributed to the increase in income from

processing and manufacturing, trading and transport services financed by the

bank. Thus, the study concluded that, the grameena bank made positive

contribution to the alleviation of the poverty in its area of operation.

Singh and Kalkundrikar (1988)22 in their study have come to the

conclusion that regional rural banks have exclusively financed the weaker

sections, showing the image of small man's bank.

Ramakrishanan (1988)23 in his study revealed that the support from

the state governments were not forthcoming to the extent it was envisaged

and expected by the working group on the regional rural banks. The study

also suggested entrusting the control of the regional rural banks to their

22 Singh, R.P. "Disbursement, Overdues and Factors Affecting Repayment Capacity of Barrowers" Indian Journal ofAgricultural Economics, Vol.43, No.3, 1988, New Delhi,.p.433.23 Ramakrishnan K.R. “Problems and Prospects of Regional Rural Banks” The Banker,Vol.No.43, March, 1988,Mumbai, pp 34-36.

10

sponsor banks. In an article, Sahana Ghosh (1988)24 found that the primary

objective of taking banking services to un-banked areas had been fulfilled by

the regional rural banks. The study made it clear that, since the objective of

the regional rural banks had been the extension of credit to the rural poor

and not based on the profit motive. It is not justifiable to argue that the

concept of the regional rural banks should be done away with, only because

they are proved to be unprofitable.

Rao (1988)25 in an article examines the inherent problems of regional

rural banks. Since there are different agencies like reserve bank of India,

National Bank for Agriculture and Rural Development (NABARD), sponsor

banks, Government of India, etc, to control the regional rural banks, several

decisions are delayed for want of clearance by one after the other agencies

concerned. So, the study suggests amalgamating all the existing regional

rural banks to form a single national rural bank under the single agency.

The reserve bank of India conducted an important and scientific study

in 198826 to evaluate the financial viability of regional rural banks. The

study covered 15 regional rural banks; four branches of each regional rural

bank were also taken for in-depth study. The regional rural banks selected

24 Sahana Gosh, “Losses no justification for Removal”, Business Standard, Vol.No.54, October 4, Mumbai, 1988, p.5.

25 Rao, P.S.M, “Inherent Weaknesses of Regional Rural Banks”, The Hindu, April 3, Chennai,1988, Supplement, p.1.

26 Reserve Bank of India, Rural Credit Planning Cell, Mumbai, 1988, pp 67-69.

11

were divided into two categories, viz., A and B. The regional rural banks

whose business exceeded three crore rupees or those who completed three

years of service were brought under category A and others in category B.

The study revealed that the performance of banks in category A, both in

terms of deposits and loans was better than the banks in category B. This

was obviously because of the fact that the proportion of business rendered

by category A banks was higher than the others.

Parmar, et.al.(1988)27 conducted a study on regional rural banks in

Gujarat state. The study found that, about two thirds of the total deposits

were shared by demand deposits. The branch expansion programmes and

credit deployment were also commendable.

Naidu and Naidu (1988)28 in a case study of 48 borrower households of

rural artisans financed by Rayalaseema grameena bank showed that regional

rural banks were able to play a major role, but that, its credit operations were

impaired by the limited knowledge on the rural artisan sector.

A comprehensive study on regional rural banks was conducted by

27 Parmar G.D. etc al, "Performance of Banaskantha-Mehsana Grameena Bank in Gujarat State" Agricultural Banker,2(3) July-September, 1988, New Delhi, pp.23-25.

28 Naidu. L.K. and Naidu, M.C, "Financing of Rural artisans by Regional Rural Banks-A Case Study of RayalaseemaGrarneena Bank in Cuddapah District " in Bank Finance For Rural Artisans (Ed), Naidu. L.K. Ashish PublishingHouse, New Delhi, 1988, pp 56-58.

12

Shete and Karkal (1989)29, one of the important findings of the study was

that regional rural banks had not neglected the backward states and regions

in spreading the banking services and in serving the rural tribal population.

Dhabal and Bhattacharya (1989)30 examined the overdue and

recovery aspects of regional rural banks credit. All these studies made

concern about the mounting overdues of regional rural banks. Some of the

important suggestions of these studies to improve recovery were effective

supervision by the bank officials, organizing recovery camps, promoting the

intention to repay by the farmers and finally, resorting to legal action against

selected affluent few and willful defaulters, etc.

Moin Quazi (1989)31 in a study found that regional rural banks have

given a massive support to self-employment generation in the rural areas.

They also play major role in the implementation of Integrated Rural

Development Programme, (IRDP).

Hebber (1989)32 argues that viability is not a criterion to judge the

performance of regional rural banks. He suggested that the regional rural

banks should be merged in the state to form one regional rural bank for each

29 Shete. N.B. and Karkal, G.L. "Regional Rural Banks: Problems and Perspectives of Rural Credit", Prajnan, Vol.XVIII No.2, 1989, New Delhi, pp 131-134.

30 Dhabbal A.and Bhattacharya, K. "Poor Recovery of Institutional Loans: An Analysis of its causes" Indian Journal ofEconomics' 69(274), I989,New Delhi, pp.307-310.

31Moin Quazi, "Banking and Rural Development", Financial Express, September 23, Mumbai, 1989, p.6.

32 Hebber,A.R.K,"Grameena Banks-Viability No Creiterion", The Economic Times, December 30, Murnbai, I989, p.5I.

13

state with its own rural branches.

Krishnan (1990)33 in a study reveals that, though there have been

tremendous developments in the field of branch expansion, deposits and

advances by regional rural banks, the problem of overdues is very serious.

Shete (1990)34 also commented on the overdue problem of regional rural

banks and suggested that they should consolidate the regional rural banks

and their branches, rather than expanding further.

Velayudhan (1990)35 examined the various aspects of regional rural

banks viz. growth and performance; problems like recovery, mounting

losses, viability, management problems, industrial relations, etc. In the light

of the multi-agency approach to rural credit and as an instrument of income

distribution in rural areas, regional rural banks have an important role to play

in rural development.

The agricultural credit review committee headed by A. Kushro

33 Krishnan, C. “Regional Rural Banks and Rural Development”, Yojana, Vol.33 No.24, January 1-15, 1990, pp.32-34.

34 Shete N.B, Regional Rural Banks- An Analysis” National Bank News Review, Vol.6.No.7, September, 1990, Mumbai, pp.32- 44.

35 Velayudhan, T.K. "Regional Rural Banks and Rural Credit-Some Issues", Economic and Political Weekly, Vol.XX,

No.38, September 22, 1990, New Delhi, pp 157-159.

14

(1990)36 was very critical of the performance of regional rural banks. The

committee made it clear that, the logic and rationale, which justified the

setting-up of regional rural banks in the mid-seventies, did not any longer

exist and it recommended to merge regional rural banks with the commercial

banks which had originally sponsored them.

A study by Balishter et.al. (1990)37 found that there had been a shift in

cropping pattern from low-income crops to high-income crops. It also

revealed that, there had been perceptible increase in the income and

employment of the borrowers due to the activities of the bank.

In a study of Chauhan et.al (1991)38 found that the demand for loans

exceeded the supply. About 35 per cent of total loans were put to

unproductive use due to urgent social expenditure needs. It was also

revealed that only very little surplus income existed within the sample,

ranging seven per cent to 16 per cent to the average household.

A Working Group (1992)39 under the Chairmanship of Sri. S.M.

Kelkar was constituted to review the various aspects of the working of

36 Reserve Bank of India, Report of the Agricultural Credit Review Committee (A Review of the Agricultural CreditSystem in India), New Delhi,1990, pp 43-44

37 Balishter et.al, "Role of Regional Rural Banks in up-liftment of Weaker Sections-A study in Agra District of UttarPradesh" Agricultural Situation in India, Vol.XLV, No. 5 August, 1990, New Delhi, pp.345-349.

38 Chouhan, B.R.S et.al, “Income and Savings of the Weaker Sections consequent upon Financing by Regional RuralBanks in Etwah District of Uttar Pradesh" Agricultural Situation in India, Vol.45 No.11, 1991, New Delhi,pp 761-765

39 Reserve Bank of India, Report of the working Group on Regional Rural Banks (Kelkar Committee) New Delhi,1992, pp 24-26.

15

regional rural banks for the past few years so as to identify appropriate

measures for strengthening their organizational structure and improving their

overall capabilities. The working group, which submitted the report in June

1992, recommended the continuance of regional rural banks and greater

involvement of sponsor bank in their functioning.

Kallu Rao and Shaji Thomas (1992)40 in a study about Manipur rural

bank revealed that the percentage growth of deposit was not satisfactory

among the various types of deposits, viz, savings bank account deposits and

time deposits. The recovery percentage was unsatisfactory and in all the

years it was below 50 per cent. However, the bank had managed to maintain

more than 100 per cent credit deposit ratio throughout the study period.

The study strongly felt the need to raise the margin from one and a

half per cent to five per cent to give boost to the working funds of regional

rural banks. It suggested that regional rural banks should have to expand

their loan business at a compound growth rate of 35 percent so as to become

viable institutions. The study concluded with the observation that regional

rural banks need six years time and a network of 70 branches to become

40Kallu Rao, P, and Shaji Tomas, "Performance of the Manipur Rural Bank-An analytical Study" Journal of RuralDevelopment, Vol. 11 No.4, July, 1992, New Delhi, pp 443-59.

16

financially viable in their operations. The study also observed that raising

new loans requires, filling out redundant forms, screening and monitoring

borrowers diligently and pursuing collections intensively, if one was to be in

compliance and maintained good asset quality. For a long-time, employees

of a bureaucracy had never linked remuneration to performance, there were

no incentives for RRB managers and staff to push harder, get motivated, and

turn their branches around, if they did not participate to facilitate success in

rural financial intermediation. The provision of incentives to staff and clients

was significant.

In this regard, rewards for officials and clients must be so designed that

the pursuit of what they consider their best interest, simultaneously

contributes to the attainment of the public interest, which is the

maximization of program outreach and sustainability. Unfortunately, the

RRB reform process has not given enough attention to designing

institutional arrangements that can align the incentives of policy makers with

those of bank's field staff and clients. Neglecting this aspect of reform can be

detrimental to program viability (1994)41. The internal efficiency of the

41 Kamath, C.C.R, “Working and Viability of North Malbar Grameena Bank- Analytical Study”, Journal of Rural

Development, Vol. 16(2), April-June1994, New Delhi, pp .31-36.

17

RRBs will not be improved, unless the field-staff actively participate in the

reform process.

The branch managers of RRBs vested with powers to make lending

decisions, freeing the staff from redundant and time-consuming reporting

requirements, can not only boost morale but also serve as the foundation for

making good loans and operating efficiently. In addition, the RRB branches

have group incentives for meeting and exceeding the outreach and

sustainability targets for their profit centers. They also need upfront

improvements in the operational infrastructure of the banks. Such actions

can include purchase of vehicles for the branches of the bank. Facade

improvements for branch buildings, construction of new storage spaces for

files and loan records and introduction of new MIS (Management

Information System) to facilitate data storage, retrieval and manipulation can

serve as signals of credible commitment on part of the owners and may go a

long way in making the RRBs more useful. While rural clients will certainly

notice the introduction of new banking values, investments in physical

improvements may not be sufficient to change their perceptions regarding

the innate inefficiencies of the RRBs. It may be difficult to provide them

with information at village-level forums, regarding the new and improved

business practices of the banks. Perhaps the most important of these

18

incentives will be the introduction of new loan products and financial

services that take into consideration local conditions and unique needs.

Much against the findings of the earlier study, this study points out

that regional rural banks should be allowed to lend to the richer sections of

the villagers. By and large it was observed that the recovery performance of

the regional rural banks was satisfactory. This study suggested that

repayment should be linked with marketing of their produce through

marketing federation, like sugar factories, milk collection centers, etc. to

ensure speedy recovery. To inculcate the habit of saving through banking,

the study suggested that the regional rural banks should widely publish the

range of their services to the rural poor. Having, considered the plight of the

staff of the regional rural banks. It is suggested that rural youth with fewer

qualifications may be recruited and trained for the placement in regional

rural banks. These people tend to show more commitment when compared

to the graduate trained in urban set-up.

Later, at the instance of Government of India, the Reserve Bank of India

appointed a committee (1994)42 under the chairmanship of Mr.B. Sivaraman

to review the credit needs of agriculture and rural development. As a part of

42 Reserve Bank of India, Committee to Review the Arrangements for Institutional Credit for Agricultural and RuralDevelopment, 1994, Mumbai, p.84

19

its study, the committee assessed the performance of regional rural banks. It

preferred regional rural banks to the branches of commercial banks in rural

banking as regional rural banks had more local feel and low cost operations.

Regarding the transfer of rural business by commercial banks to regional

rural banks, the committee strongly advocated that regional rural banks had

been meant for weaker sections and rural poor only. It was against the policy

of nominating two political leaders as directors by the government. Instead,

it was suggested that the nomination of representatives of progressive

farmers and social workers should be made from the persons connected with

rural development of the board.

In order to ensure uniformity, it is better to have single overseeing

authority. Hence, the committee suggested that the entire control and

regulation, promotion and development of regional rural banks should take

place, with the members of the National Bank for Agriculture and Rural

Development (NABARD). The committee also felt that facilities like

concessional refinance from reserve bank of India, lower standards of

liquidity, slightly higher rates of interest on deposits which were enjoyed by

the regional rural banks hitherto should be continued so as to make them

economically viable.

20

V.A. Panandikar (1995)43 conducted a study to assess the performance

of top five rural banks of India (in terms of deposits) in 1995. This study

brought a few things into limelight. (i) regional rural banks have become

very important credit agencies especially in the backward states, where the

extent of banking coverage was inadequate (ii) most of the regional rural

banks have confined their credit to weaker sections (iii) The cost structure of

the regional rural banks was definitely lower than that of a commercial

banks. Further, the study indicated that the present nexus between regional

rural banks and commercial banks may be continued for further

development. It strongly felt that National Bank for Agriculture and Rural

Development (NABARD) should be identified as an apex body for

controlling and regulating the activities of regional rural banks and to imbibe

organizational competence among them.

Another interesting empirical study was conducted by Varde Vasha

(1995)44 to analyse the overall performance including profitability of

regional rural banks. For this purpose, a sample of 40 regional rural banks

was picked-up. This study followed elaborate and complicated process of

43 Panandikar V.A. Regional Rural Banks, The Economic times, 26, June 1995, Calcutta, p.9.

44 Varde Vasha S.Singh Sarnpat P. "Profitability and performance of Regional Rural Banks" Prnjnan, October-December 1995, Vol. Xl No.4 Murnbai, p.97

21

ascertaining different ratios for the purpose of analysing the profitability of

regional rural banks. It indicated that the profitability performance of

regional rural banks showed increasing trend. This was mainly because of

the decline in manpower bill and other operating expenses. The study also

compared the manpower and operating ratio of regional rural banks with

those of commercial banks and concluded that it was lower with commercial

banks. This was mainly because of higher volume of business handled per

employee of commercial bank as compared to its counterpart in regional

rural banks. This study felt that this position could be reversed in future, if

regional rural banks enlarged the volume of business. The study came out

with a constructive suggestion that local people should be allowed to

participate in equity and no-target group (rich farmers) be lured for the

purpose of mobilizing additional funds.

RRBs have become an important instrument for bringing about

primary income distribution. The role of RRBs cannot be lost sight of, given

the national objective of development with social justice. The expenditure

incurred on RRBs should be viewed as investment in weaker sections. Thus,

from its very inception, the focus of the RRB system was to promote social

justice through credit disbursement. Serving the poor and making a profit

were seen as inherently contradictory. Since increasing outreach and

22

covering costs was neither a stated objective nor a performance measure,

financial viability was never made a priority by any stakeholder. The

challenge of RRBs governance needs should be understood in terms of

constraints related to its ownership, control and management. In principle,

each RRB was capitalized and owned 50 per cent by the government of

India, 15 per cent by the state government and 35 per cent by the (state-

owned) commercial bank, which agreed to sponsor it. In practice, the

owners, usually the state governments were in default on their contribution

and thus weakening the equity base of the banks (1996)45. Lack of interest in

investing on the part of the shareholders resulted from the lack of incentives

in contributing to the ownership. Specifically, since the RRBs were a

money-losing proposition from the very beginning, the prospect of

participating in future profits was dim for the investors.

The multiple ownership of the RRBs led to a range of bureaucratic

controls. These were specially claim in the case of RRB schemes, such as

the Indian rural development program (IRDP), in which a combination of

government subsidy and term credit (in the ratio of 1:2) was provided to

farmers and artisans to foster self-employment. Although IRDP schemes

were formally housed within the RRBs, and lending conducted under the

45 Joshi. P.N. "Decade of Nationalized Banking" Journal of Indian Institute of Bankers, April-June, 1996,Mumbai,p.60.

23

scheme affected the banks' financial statements. Hence, the program was

implemented through separate district-level entities known as District Rural

Development Agencies (DRDAs).

The governing body of the DRDAs has included locally elected

representatives at the national, state and district level agencies, as well as the

heads of various district development departments that looks after the rural

development programmes from time to time. A separate State Level Co-

ordination Committee (SLCC) monitors the program at the state level, while

the ministry of rural areas and employment is responsible for program -

funding, monitoring, and evaluation. While some controls from these

various entities translated into faulty business policies, others resulted in a

thicket of reporting rules and regulations issued by higher government

bodies and departments, such as the Reserve Bank of India and the National

Bank for Agriculture and Rural Development (NABARD), India's apex

refinancing agency for rural finance institutions owned by the ministry of

finance and the Reserve Bank of India, the ministry of finance and the state

governments (1999)46. Many such reports overlapped in their requirements,

wasting time and effort for the bank staff.

Rural banking policies, especially those prescribed by the RRB Act,

46 NABARD, “Report on working of Regional Rural banks” Economic and Political weekly, Vol. XVIII, No.2, 1999,New Delhi, pp 13-16.

24

made it difficult for the bankers to build a viable business model. For

example, the RRBs were required to maintain high statutory liquidity ratios

(SLR) of 25 per cent, a constraint that reduced the availability of capital.

Also, the yields on SLR were lower than the prevailing lending rates and

thus implicitly taxed the RRBs. Further, unstandardised norms for income

recognition made it difficult to assess accurately the financial performance

of the banks, since income on loans included both interests that were paid as

well as interest that was due. Not knowing how long interest payments had

been in arrears, most managers found it difficult to provide for non-

performing assets (1999)47.

In addition, constraints with respect to selecting borrowers, defining

geographic markets, opening and closing branches, making and collecting

loans, resulting in administrative costs, and setting interest rates were the

key barriers for enhancing financial sustainability. For example, loans were

to be disbursed in the absence of collateral security to economically weaker

sections of the rural population and households with land holdings less than

6.5 acres and incomes less than Rs.10,000, located in specific and restricted

geographic areas. Banks were allowed to lend only predetermined amounts

47 Thokhi, M.R. and Sharma , D.P. ‘Rural Banking in India’ Oxford & IBH Publishing Company, 1999, New Delhi, pp

23-26.

25

for specified lending terms. Loans are disbursed for production purposes

only; consumption credit was seldom granted. In the case of the IRDP

scheme, the eligibility criteria were even more restrictive.

It was stipulated that at least 50 per cent of assisted families belong

to lower in status in terms of castes and tribes; 40 per cent of the clients were

women, and three per cent of the credit should be disbursed to the physically

handicapped individuals. The actual selection of such borrowers was done

not by lending officers, but by local government officials, who sent lists of

approved individuals to the banks for loan disbursal. One outcome of these

restrictive policies was an increase in loan losses because of bad lending

decisions and those in need of credit for consumption often falsified loan

requests. The government authorised the increase of loan volume to meet

quantitative targets, but the bank staff had little power or incentive to engage

in due diligence and to assess the risks of lending to such individuals. Thus,

lending decisions were often reduced to making superficial matches among

individual’s socio-economic profiles from the available schemes.

Further, since many schemes, including IRDP, called for the

disbursement of a one-time loan, neither the lenders nor the borrowers were

interested in maintaining a long-term relationship. Even though many poor

borrowers did not have the ability to be productive, also they hardly had the

26

capacity to repay the loans. They participated in the programmes to have

access to what they thought was free money from the government. In most

cases, it was the wealthier sections of the community, with connections and

political patronage, who were benefited from the schemes. These well-to-do

borrowers felt little pressure to repay their debts.

While the above factors hurt the cost structure of the RRBs, the

government imposed ceiling on interest rates that dealt a severe blow to the

financial viability of the banks. Since these rates were fixed at 1. 2 per cent

on loans below Rs.2,00,000, and most of the RRB portfolio was confined to

loans of this size, the banks were unable to enhance the charges for making

and servicing the small loans(2000)48. This meant that the banks had more

than double their average lending rates of 16.6 per cent or more than half

overdues, just to break even during that year. But given the high profile of

political stature of the RRBs, most observers felt that the implementation of

high interest rates was clearly not possible in view of the mandated role of

these institutions for financing the weaker sections at concessional rates.

The challenges related to the RRBs objectives, governance structures,

48 Reserve Bank of India, Report of the performance of Regional Rural Banks (Narasimham Committee) 2000, NewDelhi, pp 51-54

27

and business model triggered additional constraints at the bank-client level.

These constraints were related to the lack of appropriate infrastructure, low

levels of motivation among RRB staff, and an inefficient loan delivery

system. The RRBs were originally envisioned to serve as low-cost rural

extensions of the banking system. A few investments were made in the

development of infrastructure. According to field studies, many bank

buildings were insecure and lacked appropriate rooting and access to basic

amenities, such as water and electricity. Equipped with old furniture and

dilapidated filing cabinets, storage space within many branches was lacking

loan documents and records were often found stacked across the floor. Bank

staff was neither provided vehicles nor a vehicle allowance to visit clients. It

was due to lack of appropriate infrastructure at the banks, and living in the

villages, made working a difficult proposition. Many staff members

abstained from work to avoid the adverse work environment, choosing to

live in semi-urban areas outside the RRB villages. As a result, some

branches of banks were open for only 18 hours a week, while others closed

down several times a month to catch up on internal paperwork (2000)49.

These practices were inconvenient for clients who often took their business

49 Sanjay Sahu, "Financing and Rural Development" Economic Times, September 23, 2000. Mumbai, p.12

28

elsewhere.

Lack of basic infrastructure within the bank branches, lack of

appropriate residential facilities in most villages and perhaps most

important, the money losing business model of the RRBs, many sponsor

banks assigned their junior officers who lacked the skills of appropriate loan

underwriting or business management to head the branches of rural bank. In

case where senior managers were placed at the RRBs, the officer’s peers saw

the placement as a punishment for possible inferior performance in the

urban- sponsored banks. It was very known to the staff that the assets of

RRBs were a very small percentage compared to the sponsor-bank assets.

The RRBs were ultimately loss leaders. The parent banks did not want to

invest any significant time and money towards their maintenance or

improvement. Therefore, the officers who were posted at RRBs generally

had low morale to begin with. This was often reflected in their lack of

willingness to be innovative and entrepreneurial. The RRBs were able to

ultimately do little to improve the situation of the poor. The day-to-day work

requirements at the RRBs did little to boost motivation of such officials.

Bapanna (2001)50 studied the organization and working of four

regional rural banks in Rajasthan. The study came to the conclusion that,

50 Bapanna, M.S.”Regional Rural Banks in Rajasthan”, Himalaya Publishing House, Mumbai, 2001, pp 32-35.

29

there was spectacular increase in branch expansion, deposits and advances.

The credit deposit ratio of regional rural banks was higher than that of

commercial banks. The recovery performance of the banks was better in

respect of non-agricultural sector compared to agricultural sector.

Abdul Noorbasha and Jyothi (2001)51 conducted a study pertaining to

the financial management pattern of Chaitanya grameena bank, Tenali of

Andhra Pradesh. The study showed that most of the regional rural banks

were nonviable. To improve the viability of these banks, the authors

suggested to allow regional rural banks to lend money to public bodies like

Scheduled Castes and Scheduled Tribes Corporation, housing boards, village

panchayats, etc; and in turn, increase their earnings.

With a plethora of reporting requirements, the redundancy of multiple

forms and procedures, the bank staff found themselves engaged in other

activities. A focus on bureaucratic compliance displaced the need to make

good loans, monitor their performance and emphasize the need for timely

repayment (2001)52. The strong focus on reporting, however, took from three

to six months for the branch mangers to identify borrowers in default. When

defaulting borrowers were not contacted for consecutive months, they

51 Adbul Noorbasha and Jyothi, M. “Viablity of Regional Rural Banks-A Case Study” yojana Vol.33, May 16-31,2001, New Delhi, pp 18-20.

52 Sankarayanan,V."Rural Banks and microfinance", Financial Express, September 22, 2001, Mumbai, p.21

30

assumed that the banks did not care for collecting the loans. This further

reinforced the culture of loan defaults. Since RRB pay scales which until

recently were lower than those of their peers in sponsor banks were not

linked to performance, bank staff had little reason to improve efficiency or

to push hard and collect on non-performing loans. In fact, the unattractive

compensation scales created strong incentives for corruption, which, over

the years, became systematic within the RRBs (2001)53.

Inefficiencies in the loan-delivery system resulted from inflexible

lending practices and high transaction costs for clients. Loan products were

usually long term required repayments and were tied to specific types of

investments that were assumed to have predetermined cash flows. An even

applicant with good credit histories and collateral systems was able to be

turned down if their requests did not fit the various RRB schemes. Since

such schemes laid out the terms and conditions of the loan, the unique

financial conditions of applicants, especially in terms of the complexities of

their family's cash flows and their repayment capacity, were never a

consideration in lending decisions. In addition to inflexibility in lending,

high transaction costs also created disincentives for borrowing. Loan

53 Kuchaditya, D.B. and Shiyani, R.L, "A Retrospection in overdues of Regional Rural Banks" Agricultural Banker,Vol. No. IV, October-December 2001, Mumbai, pp 5-8.

31

applicants were required to produce a ‘no dues certificate’, which served as

proof of good credit standing before they receive loans. Obtaining these

documents often took several weeks. Also, applicants were required to

submit a photograph as part of their loan proposal, but no technology to

obtain a photograph existed in villages. Further, if individuals wanted to do

business with an RRB outside their service area, a ‘no objection certificate’

has to be obtained from the bank within their service area.

These practices accounted in part for the long time, sometimes nearly a

month that it took for loan applicants to get approved and funded. Finally,

many prospective borrowers especially those who were illiterate, approached

middlemen to facilitate access to funds. These middlemen charged

significant commissions and fixed transaction costs that diluted the value of

the ultimate loan amounts to the borrowers. Borrowers faced transaction

costs that were much higher compared to other financing sources. Indeed, it

is not surprising that many rural farmers and small-scale entrepreneurs, who

generally value convenience as compared to the cost of credit, turned to

informal sources for their credit needs.

Further, many borrowers who incurred high transaction costs might

have avoided repaying loans, as a way to shift some costs back to the RRBs,

thus contributing to their non-viability. Enhancing the viability, the RRBs,

32

banking reforms addressed these institutional constraints and preserve

incentives in the RRB system. What more additional reforms are needed to

make the RRBs viable? Key RRB reforms based on the recommendations of

the Narasimham Committee Report were initiated to turn the failing RRBs

around. To enhance financial viability, a new set of prudential accounting

norms of income recognition, asset classification, provisioning, and capital

adequacy were implemented.

Banks were also required to make full provisioning for bulk of their

non performing assets (NPA). Further, they were permitted to lend to non-

target group borrowers up to 60 per cent of new loans beginning in the year

2001. Permission was also granted to introduce new services, such as loans

for consumer durables. In the year 2001, a major recapitalisation program

was initiated to strengthen the balance sheets of failing banks. Seventy weak

RRBs were relieved of their service area obligations and permitted to either

relocate their loss-making branches at specified locations, such as village

markets and agricultural produce centers, or to merge them with other close-

by potential branches. Also, all RRBs were permitted to invest surplus funds

in more profitable avenues, such as the money market. Further, business

plans for achieving financial viability in five years were formulated in the

form of performance contracts between the RRBs and the NABARD.

33

Finally, in 1997, RBI and NABARD delegated the responsibility of RRB

management to their sponsor banks, although there was no change in the

multiple-ownership structure. While it was expected that these initiatives

would enhance the efficiency of the financial sector, turn the failing banks

around and ultimately expand the delivery of financial services in rural

India, this had not been the case.

A number of studies indicated that while the reforms introduced an

enabling environment, for efficient financial transactions, they had done

little to increase the internal efficiency of the RRBs (2001)54. Specifically, a

two decade administrative culture had stifled creativity and made the staff of

the bank mere paper pushers. But later they became experts at handling the

multiple reporting demands of regulatory bodies. A key reason for this is

that the basic incentive problems facing the RRB system had not been

resolved. Getting the incentives right for the 70,000 plus RRB employees,

then, the new institutional arrangements triggered by the reforms might

impose yet another set of rules that might require compliance. Since

attaining financial viability is their chief constraint, it is natural for RRB

managers to take advantage of the new rules of the game and engage in

54 Patel K.V.and Shete, N.B. "Regional Rural Banks: Performance and Prospects" Prajnan, Vol. IX No,.l. January-March, 2001,New Delhi, pp 38-40

34

activities that allow them to maximize performance with the least risks.

Thus, it is not surprising that RRB managers seem to have reduced their

lending to disadvantaged groups and increased their money market

investments. Doing so is the only rationale for a number of reasons. First,

managers understand that without reduced transaction costs, incentives for

repayment, and innovative loan products in place, it is difficult to expect

previous borrowers who are not accustomed to a culture of loan repayment

to change their behavior and repay new loans on time. Therefore, lending to

old clients is risky. Secondly, although it is possible for them to make loans

to non-target group clients from outside their service areas, most RRB

managers find themselves lacking in credit appraisal skills. Again, lending

without analyzing the quality of the credits is risky (2002)55.

Specifically, a key incentive is the willingness of RRB staff to make

loans for any purpose, as long as applicants can demonstrate repayment

capacity based on current household cash flows. Further, it is critical to

communicate a new culture of enhanced customer service by ensuring

convenience and low transaction costs for clients. Also, incentives such as

intensive collection strategies and interest rebates for prompt payment

55 Balram,. M.S. “Rural Banks and Rural Uplift”, Prentice-Hall Publishing House, New Delhi-2002, pp 54-58.

35

encourages timely loan repayment. In sum, the key to turning the RRBs

around and placing them on a path of increasing outreach and sustainability

is to devise and implement institutional arrangements that harmonize public

interest objectives with the private incentives of bank staff and clients.

The performance of the RRBs during the last two decades can be

largely attributed to their lack of commercial orientation. Instead of adopting

international best practices in micro finance, especially in terms of reducing

transaction costs for clients and lending to individuals based on an appraisal

of their ability and willingness to repay, these internally inefficient banks

made loans based on political and social considerations that caused the very

fundamentals of prudent underwriting. Given their poor portfolio

performance over the past decade, the majority of these banks had been

declared as financial disasters as development experts search for alternative

ways to deliver rural financial services (2002)56.

The unsustainability of the RRBs, led some observers to advocate a

greater role for Non-Governmental Organizations (NGOs) and self-help

groups in rural financial intermediation. While many such entities seemed to

have reduced transaction costs and maintaining low loan losses, their

outreach was severely limited to the size of India's rural market. Rough

56 Nandan, "Financing of Grameen self-help groups by RRBs - A study of Pinakini Grarneen. Bank Nellore District"-Bank Finance for self-help groups , Ashish Publishing House. New Delhi, 2002, pp 36-39

36

estimates suggested that the total outreach of all the NGOs engaged in rural

finance was not more than 5,00,000 households (2002)57.

An estimated market potential of over 50 million households, there is

little chance that NGOs can meet market demand. On the other hand, the

RRB system and staff, despite their challenges, have inherent strengths such

as an extensive infrastructure in place for financial services delivery, an

understanding of the economics of the local markets within which they

operate, a reputation among many poor households for being client-friendly,

and a comparative advantage in mobilizing low-cost deposits from sources

that commercial banks do not adequately reach.

A historical review of rural credit in India goes as far back as 1915 when

the co-operative sector came to the rescue of people to provide financial and

other inputs for the agricultural growth. There were many operational

changes from time to time in this system over a period of time during the

pre-independence era. The movement picked up fast during the post-

independence period. In view of the added importance attached to the

growth of agricultural sector, the issue of credit delivery system was given

considerable thought and the banking system was brought into picture.

57 Reserve Bank of India Report on “ Progressive functioning of Banking in lndia”.2002, Murnbai, pp 34-37

37

Without going into many details, institutions started with the entry of the

state bank of India through its exclusively identified agriculture finance

branches. Thereafter, the major nationalized commercial banks were made

partners in the rural credit system of our country.

Another attempt was made by a group of academic researchers to look

into the operational efficiency of regional rural banks58. This study was too

general in nature and elaborates in its presentation. Moreover, a sea change

has occurred in rural economic scenario. The findings of the study are

inappropriate under present circumstances. Hence, an objective study is

contemplated on scientific lines basing on the latest data. In addition to this,

the role of the regional rural banks is enlarging from one activity to the other

in rural areas in restructuring the rural activity and thereby offering

increased standard of living to rural masses. Regional rural banks have been

emerging as an innovation in organized banking system. Institutional

financing for rural development is an important area that needs to be studied

in depth.

The study group of the Reserve Bank of India felt the need for

undertaking selective case studies on regional rural banks for their better

58 Das VBM, Prabhakar Rao, J.V. Hrushikesava Rao, Satyanarayana G. "Role of Regional Rural Banks in RuralCredit", March, 2002., pp.224-230

38

evaluation in view of their working in different socio-economic

environmental set-up. Against this background, this study was intended to

find out the role of the regional rural banks in promoting rural development

through its multi-farious activities.

Most of the key parameters are studied in-depth so as to bring out the

real impact of the functioning of regional rural banks. Important aspects like

branch expansion, deposit mobilization, problems of overdues, share of the

bank in district credit plans etc, are well attempted to highlight the role of

the bank in rural development in various chapters.