Financial Inclusion – Case of China and India

Financial services of various types include many economies of the world and they can benefit their common growth. Thus, both developed countries and developing ones have banking sectors that allow their financial systems to function. However, banking services in different countries can be available not to all population groups. Financial inclusion can be defined as an extension of financial services to all members of society, all population, and income groups, including the poor, and individuals even with limited financial literacy to decrease income inequality and increase the growth of the economy. Thus, financial inclusion policies, stimulating the activity of individuals and helping to overcome barriers to the availability of finance, not only guarantee the stability of development. They are also necessary for economic growth, poverty reduction and more equitable distribution of cash flow resources because financial inclusion can provide the necessary volumes of investment resources. Thus, financial inclusion will be investigated in this paper on the example of India and China.

The History of the Issue

India and China reflect the current situation of financial exclusion and inclusion. Both countries have a huge population, some groups of which are in need of financial inclusion in the banking sector. While tracing the history of this issue in China, one should note that the first phase of it began during the reign of the last Qing Dynasty (1644 – 1911 years) (Aziz, Dunaway, & Prasad, 2006). The small percentage of the population was included in it since the system was feudal. Even later, banks only served trade and worked with bills. After the democratic revolution of 1911, banks came under the financial control of the foreign business, and the population slowly began to use investment services (Aziz, Dunaway, & Prasad, 2006). Up to the beginning of the 21st century, after 30 years of radical and different reforms, China’s new banking system has been created from the old Soviet-style organizational structure, having a classic two-level building (Aziz, Dunaway, & Prasad, 2006). Thus, China smoothly and naturally realigned its banking system according to the image of the most common models of the market economy. The natural consequence of this approach was the leap to the increase of public inclusion (Aziz, Dunaway, & Prasad, 2006). It used the tools of support of foreign trade, domestic, and foreign investment. Therefore, the tendency of inclusion was positive as it had steady growth.

In India, at the time of independence, credit institutions were represented by numerous small banks in large cities. In order to overcome the problems, the law of adoption of the regulations of the banking sector was made in 1949. It allowed further undertaking a number of structural reforms in this area (Aziz, Dunaway, & Prasad, 2006). Having come to power in July 1991, Prime Minister Narasimha Rao adopted a program of stabilization measures, the key point of which was the introduction of radical changes in the country’s banking system to increase the involvement of the population (Aziz, Dunaway, & Prasad, 2006). Consequently, the history of both countries shows the progress of the issue; however, the situation remains critical.

Theory of Financial Inclusion and Possible Benefits from It

For further study of the issue, its theory should be considered regarding the benefit of financial inclusion. The revitalization of funding mechanisms involving the population in the banking sector increases investment processes (Demirge-Kunt, Beck, & Honohan, 2008). Thus, there is a capital inflow in the national industry through investment resulting activity of the banks, which allows compensating the outflow of capital from the country as the national economy enlivens through the growth of the financial sphere. Further, the enlivening of the economy can increase the growth of gross domestic product and national income (Demirg??-Kunt, Beck, & Honohan, 2008). This, in turn, can reduce inflation expectations, improve the living standards of citizens, and reduce social differentiation. The total involvement of the population in the banking sector brings a general revival of the economy through financial connections with other sectors. Consequently, it increases the welfare of its citizens (Demirg??-Kunt, Beck, & Honohan, 2008). There are also specific benefits for those, who are not registered and not included in the banking sector, since it means the independence of the population from the financial fall in the banking sector, thus reducing the risk of bankruptcy at depositing and bringing independence from the influence of the system. However, their materiality is insignificant in comparison with the described benefits of financial inclusion; consequently, the benefits from inclusion are urgent, so the development of inclusion can be estimated as positive.

Current Situation of Financial Inclusion in China and India

At the moment, 19% of account holders in China make payments from bank accounts using mobile phones, which can be compared to 13% on average in developing countries. In addition, 79% of adults in China have accounts in banks versus 64% in 2011. For public authorities and the private sector, there are opportunities to reach financial services as 490 million people still do not have bank accounts (The International Bank for Reconstruction and Development, 2014). Thus, the situation in China is much better as compared to financial inclusion in developing countries.

However, financial inclusion still has significant prospects for development (Bank for International Settlements, 2016). The lack of inclusion of all segments of the population in China’s banking system leads to multiple outcomes. Firstly, not all groups are active in the investment banking sector. The results of such exceptions occur in the outflow of the capital (shortfall), thus increasing the high level of doubtful debts on the balance sheets of Chinese banks, doubtful assets on the balance sheets of Chinese, and insufficient activity to prevent the emergence of new bad debts. Finally, another dangerous problem of a systemic nature, gaining its relevance, is a lack of capital in financial institutions due to the insufficient amount of effective mechanisms for the replenishment of the banks themselves, which reduces the activity of the population.

On the one hand, the Indian banking regulatory system as well as a risk assessment system is better than in China (Bhaskar, 2013). The implementation of the standards of the Basel Accord (Basel II) stimulates the growth of international competitiveness and growth of financial involvement. Technical progress in the banking sector of India is ahead of China’s performance as well as the superior credit quality of the Chinese banks in India (Bhaskar, 2013). However, as compared to China, India has a high unemployment rate that ranges from 9% in rural areas and 12% in urban areas while total poverty of population poses a much greater problem of the financial exclusion of the population (The International Bank for Reconstruction and Development, 2014). In addition, the resilience of the Indian banking system in modern conditions has positively influenced the concentration of 75% of all deposits of the country in the state banks, which excludes the failure of banks and the emergence of significant problems with their liquidity and lending to the economy (Bhaskar, 2013). Due to a large number of poor people in the country, the state policy in the sphere of credit has a strong social dimension (Bhaskar, 2013). In India, the growth of the process of financial inclusion is better and faster than in China, but the current situation is much worse. Only about 60% of the population has access to modern banking services, while in rural areas, the level of this inclusion is much lower (about 30%) (The International Bank for Reconstruction and Development, 2014). The percentage of the population excluded from the banking sector is much greater than in China, and it is one of the highest among developing countries (The International Bank for Reconstruction and Development, 2014). Consequently, entire sections of the population do not have the opportunity to use banking services in both countries, which means that financial inclusion should be increased.

Recommendations Regarding Financial Inclusion

The system of recommendations about how to get people into the banking sector includes several important points. Firstly, China needs the formation of the existing system of compulsory insurance of deposits of the population to attract deposits of the population, and this process might require several years. Only the creation of the structure itself can take up to a year; however, due to the norms of deductions embodied in the legislation, the process of installment of such an insurance system can take at least five years. Nevertheless, the emergence of this system, obviously, can boost confidence in the banking system from the side of private investors, which can increase inclusion. The government of China must carry out the implementation of quality approaches to banking supervision such as the effectiveness of the fight against capital bloated, the formation of efficient systems of internal risk control, and establishing criteria for evaluation of bank management (The International Bank for Reconstruction and Development, 2014). In any case, it should increase the transparency of Chinese banks and enhance confidence in them.

In India, the government should strengthen the existing project “Partnership in Financing” and create a mutually supportive net of small institutions aimed at promoting microfinance and increasing coverage of the rural population with banking services (Bhaskar, 2013). State Bank of India needs to open small bank branches in rural areas. It can be mobile banking kiosks, providing a range of banking services such as payments, subsidies. Such a small net with its kiosks create coverage of 165 villages in the states of Madhya Pradesh and Chhattisgarh; however, such a grid should include more than 600 villages for the active operation (The International Bank for Reconstruction and Development, 2014). The system of micro-credit can help to give impulse to small businesses. With the development of financial inclusion, India can significantly reduce the seriousness of the problem of unemployment and poverty for large part of the population.

Measures concerning both countries at the same time should be aimed at reducing the risks of crediting. This should include the promotion of the formation of the system of credit bureaus and mitigating supervisory norms for this process from small and medium-sized businesses as well as individuals. In particular, for the development of mortgage lending, which is especially interesting for people, countries need to develop legislation governing the relationships of the main participants on this market. In India, banks, as well as other participants of the financial markets, should have the real opportunity to hedge their transactions with the use of derivative financial instruments. Such a possibility should be facilitated by the appropriate legislation for China’s banks. This will increase the financial stability of banks, which in turn will enhance the inclusion of people in the financial sector due to the rising level of common trust and the decrease in risk rates.

Furthermore, banks in both countries need to have a faster integration into the international financial community (Committee on Payments and Market Infrastructures Bank for International Settlements, 2016). Non-residents can become a real force in the Indian banking system and enhance their positions in China’s one. It will attract the inflow of capital into the financial sector and increase domestic investment. Consequently, this will increase the financial inclusion of the population due to expanding the market with economic recovery.

The government of India should clearly define the position of the state regarding its own banks: how much they need and for what purposes. Government involvement in the banking system for both India and China should not be excessive. The newly established institutions should not have the character of universal banks, and they should be used to perform special functions, such as export support, like the similar structures existing in the most developed financial systems. Therefore, it is expected that these recommendations may lead to a future increase to the trust, access, and the ability to use banking services, which means the growth of financial inclusion of the population.

Future of Financial Inclusion in China and India, Expected Results of Recommendations

Increasing the importance of the banking system in the socio-economic development of any country is provided by the increase in banks’ capital. Stable banking institutions in China will attract more people, which will contribute effectively to economic growth by taking part in the integration of banking and industrial capital and strengthening the country’s industrial potential (Committee on Payments and Market Infrastructures Bank for International Settlements, 2016). Strategic development of the banking community will be focused on the consolidation of capital, mergers and the formation of banking conglomerates, several orders of magnitude greater than the volume of existing banking structures (Committee on Payments and Market Infrastructures Bank for International Settlements, 2016). At the same time, the role of small and medium banks will be more significant in China (Committee on Payments and Market Infrastructures Bank for International Settlements, 2016). This is determined by national economic traditions, the scale of the territory, and the formation and development of small and medium-sized business forms (Demirg??-Kunt, Beck & Honohan, 2008). Thus, in India, small and medium-sized banks in the process of sustainable and effective operations will occupy a certain sector of the banking market and will satisfy most of the needs of the public (Committee on Payments and Market Infrastructures Bank for International Settlements, 2016). It can be a major factor in attracting people, which will also spur the economic growth of the country due to the increased financial activity of the population. Such recommendations will help not only for banks but also governments, as they will help the overall economic well-being of countries (Bhaskar, 2013). Even the inclusion of poor people will enhance the volume of financial relations (Demirg??-Kunt, Beck & Honohan, 2008). Thus, the volume growth of the financial sector will raise the scope of production and real GDP as well as provide more cash flow due to the increased investment.

Conclusion

Financial inclusion of the population is an important and urgent issue for both India and China. Both countries have their own history of the population included in the banking sector. However, at the present stage, the status of the population in both countries is different. In China, the banking sector involves a significant part of the population, leading the same indicators in developing countries. At the same time in India, this part is much smaller, while in rural areas, the inclusion of the population in the banking sector is strikingly low. Thus, the growth process of financial inclusion in India is significantly higher than in China. However, both countries need to proceed in this direction. At the same time, China should strengthen the population’s deposits insurance system, review the system of banking supervision, improve the transparency of its banks, and strengthen the legal framework for hedging transactions of banks using derivatives. India, in turn, should increase the emphasis on the involvement of the rural population by creating a network of small bank branches for microcredits and small operations. At the same time, measures concerning both countries should be aimed at reducing credit risk and increase the speed of integration into the international financial community. These measures will help to increase access and the public’s trust in the banking system, thus promoting financial inclusion. In the future, this will contribute effectively to economic growth, attract additional flows, and increase the welfare of the population, which confirms the thesis, put forward in this paper.