Financial inclusion in India: policy, priority sector and the FI-Index

Financial inclusion appears in both Phase 2 papers: in ESI as a development issue, and in F&M as a banking and regulatory issue. The F&M angle asks what banks and the RBI do: priority sector rules, delivery channels, measurement and consumer protection. India has largely solved access to a bank account. The live question, and the one examiners like, is whether people use formal finance in ways that improve their lives.

What financial inclusion means

The Rangarajan Committee on Financial Inclusion (2008) defined it as ensuring access to financial services, and timely and adequate credit where needed, for vulnerable groups such as weaker sections and low-income groups, at an affordable cost.

Today the idea is broader. Inclusion covers five services (savings, credit, payments, insurance and pensions) and three conditions: they must be accessible, used, and delivered fairly, with protection against fraud and mis-selling.

Why it matters:

• Households can save safely, smooth consumption and cope with shocks without moneylenders.
• Small firms get credit to grow.
• Government transfers reach people directly, with less leakage.
• Monetary policy works better when more of the economy is inside the formal system.

The policy journey

Priority sector lending

Priority sector lending (PSL) requires banks to direct a share of credit to sectors that markets underserve: agriculture, micro and small enterprises, export credit, education, housing, social infrastructure, renewable energy and weaker sections.

Targets for domestic scheduled commercial banks are set as a share of Adjusted Net Bank Credit (ANBC) or credit-equivalent of off-balance-sheet exposure, whichever is higher.

Regional rural banks and small finance banks have higher overall targets.

Worked example: PSL targets

A bank's ANBC is ₹50,000 crore.

1. Total PSL = 40% of 50,000 = ₹20,000 crore.
2. Agriculture = 18% = ₹9,000 crore, of which small and marginal farmers = 10% = ₹5,000 crore.
3. Micro enterprises = 7.5% = ₹3,750 crore.
4. Weaker sections = 12% = ₹6,000 crore.
5. Suppose its actual agriculture lending is ₹8,200 crore. The shortfall is ₹800 crore. The bank can buy Priority Sector Lending Certificates (PSLCs) from banks that have exceeded their targets, or it must deposit the shortfall in funds such as NABARD's Rural Infrastructure Development Fund (RIDF), which pay below-market interest.

The sub-targets overlap: a loan to a small farmer who belongs to a weaker section counts toward agriculture, the farmer sub-target and weaker sections at once.

Measuring inclusion: the FI-Index

The RBI launched the Financial Inclusion Index (FI-Index) in August 2021. It is a single number from 0 (complete exclusion) to 100 (full inclusion), built from banking, investment, insurance, postal and pension indicators. It has three weighted parameters:

Usage carries the most weight, which tells you where the RBI sees the challenge.

Worked example: a hypothetical score

Suppose a year's scores are Access 70, Usage 55 and Quality 60.

1. Access contribution = 0.35 × 70 = 24.5.
2. Usage contribution = 0.45 × 55 = 24.75.
3. Quality contribution = 0.20 × 60 = 12.
4. FI-Index = 24.5 + 24.75 + 12 = 61.25.

Raising usage by 10 points adds 4.5 to the index; raising access by 10 adds only 3.5.

Delivery channels

• Branches, including in previously unbanked villages, and ultra-small branches.
• Business correspondents (BCs): agents such as shopkeepers who use micro-ATMs and AePS to offer deposits, withdrawals and transfers.
• Small finance banks and payments banks: differentiated banks for small borrowers and small savers.
• Digital channels: UPI, mobile banking, and DBT into accounts.
• Microfinance and SHGs: group lending, largely to women.

The next stage: from access to usage

• Dormant accounts: many Jan Dhan and basic accounts see little activity beyond receiving transfers.
• Credit gap: small borrowers without collateral or credit history still rely on informal lenders.
• Insurance and pensions: low uptake beyond government schemes.
• Literacy: financial and digital literacy lag, which raises fraud risk. The RBI's financial literacy centres and the National Centre for Financial Education (NCFE) address this.
• Gender and regional gaps: women's usage and credit access lag; the North-East and parts of central India have thinner networks.
• Viability of BCs: low commissions and connectivity problems lead to high agent drop-out.

Model answer outline (15 marks)

Question: "India has achieved access; the challenge now is usage." Examine.

1. Introduction: definition (Rangarajan Committee); three dimensions.
2. Access achieved: PMJDY accounts, BC network, DBT, UPI reach.
3. Usage gaps: dormant accounts, limited credit and insurance, gender gap (described qualitatively).
4. Causes: low incomes, product design, trust, literacy, BC viability.
5. Policy responses: NSFI, FI-Index with usage at 45%, PSL, account aggregators and cash-flow lending, literacy drives.
6. Way forward: products designed around irregular incomes; women-focused outreach; grievance redress; data protection.
7. Conclusion: inclusion is measured by how people use finance, not by how many accounts they hold.

Short model answer (10 marks)

Question: Explain the rationale for priority sector lending. Is it still relevant?

Priority sector lending requires banks to direct a set share of their credit, 40% of adjusted net bank credit for domestic banks, to sectors such as agriculture, micro and small enterprises, education, housing and weaker sections. The rationale is market failure: these borrowers are small, lack collateral and are costly to assess, so profit-seeking banks lend less to them than is socially desirable.

PSL has helped expand farm and small-business credit and supported rural branch networks. Critics argue that it can push banks into poorly assessed lending, raise NPAs in some segments, and distort pricing.

It remains relevant, but its tools have become more market-friendly. Priority Sector Lending Certificates let banks that lend efficiently to these sectors sell their surplus to others, and co-lending with NBFCs combines bank funding with local reach. The goal has shifted from volume targets alone to credit that is well-assessed and actually reaches the intended borrowers.

Practice questions

1. Which committee defined financial inclusion in 2008?
   • The Rangarajan Committee.
2. What is the weight of usage in the FI-Index?
   • 45%.
3. When was PMJDY launched?
   • August 2014.
4. A bank's ANBC is ₹80,000 crore. What is its agriculture target?
   • ₹14,400 crore (18%).
5. What can a bank buy to cover a PSL shortfall?
   • Priority Sector Lending Certificates.
6. In which year did the SHG–bank linkage programme begin?
   • 1992.

What to do next

• Learn the policy timeline table in date order.
• Redo the PSL example for an ANBC of ₹1,20,000 crore.
• Read the payment systems guide and the fintech and CBDC guide.
• Then read the rural and cooperative finance guide.