Do Rural Banks Matter? Evidence from the Indian Social Banking Experiment
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Do Rural Banks Matter? Evidence from the Indian Social Banking Experiment By ROBIN BURGESS AND ROHINI PANDE* The question of whether state-led expansion et al., 1984; Avishay Braverman and J. Luis of credit and savings facilities can reduce pov- Guasch, 1986). Others argue that state control erty has long been of interest to economists and led to political considerations determining policymakers. A large theoretical body of liter- credit allocation and made the banking sector ature identifies different mechanisms through susceptible to elite capture (Rafael La Porta et which access to such facilities can enable indi- al., 2002; Paola Sapienza, 2004). viduals to alter their production and employ- Credible evidence on whether state-led ex- ment choices, and thereby exit poverty pansion of the banking sector can reduce pov- (Philippe Aghion and Patrick Bolton, 1997; Ab- erty, however, remains limited. The central hijit Banerjee and Andrew Newman, 1993; reason for this is the nonrandom nature of these Banerjee, 2004). The belief that governments programs. Specifically, banks favor opening can use public policy to alleviate financing con- branches in richer areas, while state-led bank straints, and thereby engender development and branch expansion programs tend to target reduce poverty, led to the widespread imple- poorer areas. This makes identification of the mentation of state-led rural credit and savings causal impact of branch expansion on poverty schemes in low-income countries in the post- outcomes problematic.1 In this paper, we eval- colonial period. In most cases this was accom- uate how a large state-led bank branch expan- plished through government oversight of the sion program in India affected rural poverty. banking sector, often aided by government The policy rules underlying the program pro- ownership of banks. vide a credible source of exogenous variation in Today, these schemes remain important in rural branch expansion. many developing countries (Timothy Besley, This program is the largest branch expansion 1995). Many believe, however, that formal sub- program undertaken by any single country. Af- sidized credit was ineffective in reaching the ter bank nationalization in 1969, the Indian gov- poor, and may even have undermined rural de- ernment launched an ambitious social banking velopment and increased rural poverty. Some program which sought to improve the access of claim that the elite capture concentrated formal the rural poor to formal credit and saving op- subsidized credit in the hands of the powerful portunities. The program ended in 1990. Be- few and worsened terms in the informal markets tween 1969 and 1990, bank branches were on which the poor depend (Dale W. Adams opened in roughly 30,000 rural locations with no prior formal credit and savings institutions (unbanked locations).2 * Burgess: Economics Department, London School of An integral element of this program was Economics, Houghton Street, London WC2A 2AE (e-mail: branch expansion into rural unbanked locations. [email protected]); Pande: Economics Department, Eco- nomic Growth Center, Yale University, P.O. Box 208269, New Haven, CT 06520 (e-mail: [email protected]). We thank Esther Duflo for very helpful and detailed com- 1 Bank expansion and economic growth are positively ments. We have benefited from comments and suggestions correlated in cross-country data (e.g., Robert King and Ross from Abhijit Banerjee, Tim Besley, Richard Blundell, Bron- Levine, 1993). The fact that countries with greater growth wen Burgess, Anne Case, Ken Chay, Jonathan Murdoch, potential may attract more banks, however, makes causal Atif Mian, Andrew Newman, Dominic Leggett, Debraj Ray, inference difficult. Mark Rosenzweig, Ken Sokoloff, Duncan Thomas, Robert 2 Throughout the paper, locations refer to villages, Townsend, a co-editor, two anonymous referees, and numer- towns, and cities as defined by the Indian Census. The ous seminar participants. Juan de Laiglesia, Mattia Romani, Census defines a location with fewer than 10,000 persons Gaurav Shah, Heideeflower Stoller, Pataporn Sukontamarn, as rural. The same holds for rural and urban poverty and Grace Wong provided exceptional research assistance. definitions. 780 VOL. 95 NO. 3 BURGESS AND PANDE: DO RURAL BANKS MATTER? 781 The stated aim was to open bank branches in the I. The Program most populous unbanked rural locations, and over time move down the population distribu- Nationalization in 1969 brought the 14 larg- tion of locations. India is a federation of states, est commercial banks under the direct control of and more of the targeted locations were situated the Indian Central Bank. Following this, the in states with fewer bank branches per capita Central Bank launched an ambitious branch ex- pre-program (financially less developed states). pansion program, which sought both to expand To further encourage rural branch expansion, the rural bank branch network and equalize the Indian Central Bank announced a new individual access to banks across Indian states. branch licensing policy in 1977. It mandated This program encouraged branch openings in that to obtain a license for a branch opening in rural unbanked locations. Banks were required a location with one or more branches (a banked to select unbanked locations for branch expan- location) a bank must open branches in four sion from a list circulated by the Central Bank. eligible unbanked locations. This policy re- This list identified all unbanked locations with a mained in place until 1990. population above a certain number. As the same Our research design exploits the policy- population cut-off was applied across India, the driven nature of branch expansion across Indian list featured relatively more locations from states. We show that between 1977 and 1990, states with a lower initial stock of bank rural branch expansion was relatively higher in branches per capita. Further, within a state, financially less developed states. The reverse more locations were targeted in districts with was true before 1977 and after 1990. The timing fewer bank branches per capita pre-program.3 and nature of these trend reversals suggest they The list was updated, with a lower population were caused by the introduction and removal of cutoff, every three years. the 1:4 branch licensing policy. By using the The 1949 Banking Regulation Act requires deviations, between 1977 and 1990 and post- banks to obtain a license from the Indian Cen- 1990, from the pre-program linear trend rela- tral Bank before opening a new branch. To tionship between a state’s initial financial ensure that targeted rural unbanked locations development and rural branch expansion as in- received bank branches, the Central Bank intro- struments, we are able to identify the policy- duced a new branch licensing policy in 1977. It driven element of rural branch expansion. This mandated that a bank can obtain a license to allows us to address the problem of nonrandom open a branch in an already banked location branch placement. Our research design assumes only if it opened branches in four unbanked that other state-specific economic and policy locations. This 1:4 licensing policy was aimed variables, which affect poverty outcomes, did at forcing banks wishing to expand in already not exhibit similarly timed trend reversals. We banked locations to open branches in unbanked show that potentially confounding variables, locations. The 1:4 licensing policy was discon- such as states’ economic performance, poverty tinued in 1990. Since then, Central Bank policy alleviation policies, and other credit programs, has stated that branch expansion should reflect did not show similar patterns. the “need, business potential, and financial via- This paper’s main finding is that branch ex- bility of the location” (Government of India, pansion into rural unbanked locations in India 1991). Banks cannot, however, close a rural significantly reduced rural poverty. We show branch if it is the only one serving a given that this effect was, at least partially, mediated location. through increased deposit mobilization and To ensure that rural branch expansion credit disbursement by banks in rural areas. In translated into increased credit and savings contrast, the rural branch expansion program opportunities for the rural population, the left urban poverty outcomes unaffected. Central Bank regulated banks’ deposit-taking The paper is organized as follows. Section I describes the Indian rural branch expansion pro- 3 In each Indian district, one commercial bank was se- gram and the data we use; Section II describes lected by the Central Bank to be the lead bank, which was our research design; Section III presents the responsible for coordinating branch expansion activities in results; and Section IV concludes. that district. 782 THE AMERICAN ECONOMIC REVIEW JUNE 2005 and lending policies. Between 1969 and 1990, ter 1990, there was no further expansion into rural lending rates were kept below urban unbanked rural locations. lending rates, with the opposite being true of Indian national household survey data docu- savings rates. After bank nationalization, the ment a dramatic rise in the importance of banks Central Bank also mandated that banks’ lend- as a source of rural household credit. Between ing portfolios meet lending targets with re- 1961 and 1991, bank borrowing as a share of spect to “priority” sectors. These included loans to total rural household debt increased from 0.3 small businesses and small-scale entrepreneurs, percent to 29 percent. This rise came largely at and to agriculture. Finally, to ensure that banks did the expense of borrowing from moneylenders, not concentrate their lending in urban areas, the the share of which fell from 60.9 percent to 15.7 Central Bank required that every bank branch percent. (For details, see Burgess and Pande, maintain a credit-deposit ratio of 60 percent 2003.) To examine whether rural branch ex- within its geographical area of operation. pansion contributed to this rise in rural credit Our focus is on examining the impact of the flows and savings mobilization, we use data branch-expansion program on rural poverty.