Question

The government of Creditland wants to increase poor households access to credit. In order to do so, it has recently added a regulatory clause on commercial banking operations: for each branch that a commercial banks opens in urban areas, it must open two branches in rural area. Do you think that this new regulatory restriction will expand credit to poor households in rural areas in Creditland?

Answer 1

These kind of mandatory financial inclusion clauses are common in the developing world where banking and credit facilities in rural areas are not readily available. There are both positives and negatives of these policies. We will review those with the focus on impact on credit availability in rural areas.

• Benefits-

The obvious benefit is, of course, that theses increase the availability and easy access of financial facilities to the rural areas. Since people don’t have to go far to avail banking facilities, they are more likely to use these branches. This will mean that more money will enter the economy, cash will reduce and increased deposits with money multiplier will mean even more money will enter as lending in the system.

But our question is asking about credit in rural areas. Now credit can’t be there without income, credit history and deposits backing it up. The new branches will definitely increase credit availability for secured loans- such as mortgages, auto-loans etc. This in turn will create a credit history for customers and combined with income, will result in higher credit available for unsecured products also, which include credit cards, personal loans etc.

Deposits are also very important in this regard. The aim of these branches should be to create real wealth as well as increased money supply in the system. To that end, if these branches have reduced minimum balance requirements, ATM charges etc, it will result in increased deposits and usage of its facilities. Poor families often might not have disposable income which they can keep in the banks to achieve minimum balance requirements. The reduction in those will help these families.

• Negatives

The negatives mostly affect the banks themselves. Any mandatory clause usually ends up creating an inefficient market and this is no different. Here the bank is forced to open 2 rural branches, which have a higher chance of not being as profitable, at the expense of one profitable urban branch. This will create a deadweight loss in itself as the bank is not opening branches in the most efficient manner. The distances involved, the higher costs of communication and setting up facilities will reduce profitability. The number of customer and money being moved might also be lower.

Overall, we can say that while the new branches, with the right measures, will increase the credit availability to the rural areas- they will create deadweight loss for the banks.