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The Reserve Bank released India’s first financial inclusion (FI) scores last month. The FI index for 2021 is 53.9 on a scale of zero to 100. The scores for the past five years have also been calculated. It was 43.4 in 2017. So there is progress.

The FI index is a composite of 97 parameters for access, usage and quality. They have weights of 35, 40 and 20 respectively. Access is measured on the basis of 26 indicators like number of banking outlets including banking correspondents, non-banks and post offices, total number of savings accounts, the subscription base for pension schemes, the Jan Dhan-Aadhar-mobile phone (JAM) ecosystem and the presence of offices and agents of life and non-life insurers.

Usage has 52 indicators. They are demand side measures and are designed to capture savings and investment habits. Quality refers to financial literacy, consumer protection and inequality in the distribution of financial infrastructure with 19 indicators that gauge the efforts made by governments, regulators and industry players to make people aware of the financial services that are available, their appropriateness, safe ways of using them and how they can overcome psychological barriers. They also reflect effectiveness of the grievance redress mechanism.

The 53.9 score has been boosted by access (73.3 points) while scores for usage (43) and quality (50.7) lag.

Financial inclusion has been a priority with all governments. It may be defined as the process of ensuring access to timely and affordable credit to micro, small and medium enterprises, small holder farmers and to poor self-employed persons, particularly women. It also includes access to appropriate pension, insurance and deposit products.

A proxy for financial inclusion is microfinance. These are collateral-free loans given for income-generating activities to women, mainly in rural and semi-urban areas. Since they don’t have collateral to offer, the lending is done on the basis of mutual guarantees given by joint liability groups, comprising borrowers who know each other. Social pressure ensures repayment as a default by one members, triggers obligations from the rest of the group.

Microfinance has come a long way. In 2014, only 0.34 lakh crore (trillion) of loans were outstanding, according to Microfinance Institutions Network (MFIN), the industry club and self-regulatory organisation (SRO). As of June, the amount had increased to Rs 2.38 trillion. There were nearly 57 million borrowers and 103 million accounts. The average amount outstanding per borrower was about Rs 35,000.

Who are the typical borrowers? The ‘success stories’ on the website of Satin Creditcare Network which is present in 23 states but most in the east and the north-east, are those of a grocer in Punjab who took a business loan of Rs 25,000 in 2015, a farmer from Assam who borrowed a similar amount to start a broiler farm, a dairy farmer from UP who has taken three loans totalling Rs 60,000 since 2015 and a woman from Bihar who took a loan of Rs 15,000 to build a toilet after her daughter got the fright of her life while relieving herself in the fields. A snake coiled around her leg but mercifully did not bite her.

The loans increased daily incomes, enhanced the self-confidence of the borrowers, and enabled them to do things they could not like sending children to English medium schools.

The MFI has loans for business (Rs 10,000 to Rs 50,000), for installation of solar lanterns (Rs 1,700-Rs 4,000), purchase of cycles (Rs 5,700 to Rs 7,000), buying an induction top or pressure cooker (Rs 2,100-Rs 3,300), a mobile phone (Rs 11,500 to Rs 14,500) and for equipping homes with clean water and sanitation (Rs 6,000 to Rs 15,000).

The interest rates are an eye-popping 21.69% at a time when interest rates have dropped. Bajaj Finserv, for instance, gives personal loans at 13% (plus processing charges of 4% on the loan amount).

An executive of Satin Creditcare explains that MFIs are not allowed to take deposits. They have to borrow from banks which charge about 11%. The Reserve Bank has capped their net interest margin (NIM) at 10%. Operating costs and provisioning for defaults erodes much of the margin. (In a consultation paper released in June, RBI has decided to lift the cap on margins, as it was applicable only to MFIs and not to banks which also provide microfinance).

Microfinance is a contact-intensive activity. One way to reduce costs is to deploy technology for filling forms, (as the borrowers are usually unlettered), vetting applicants, monitoring field staff (through geo-tagging), automating their processes, and disbursing loans digitally. Aadhar biometric identification, e-KYC, no-frill Jan Dhan bank accounts and the spread of mobile internet to rural areas has created an ecosystem for the expansion of microfinance.

Fintech firms have developed tools that allow scanners to read Aadhar cards and fill the loans application forms. Data science helps filter out fraudulent applications. Psychometric tests help sift applicants who are most likely to default. Sharing information like credit histories of borrowers (after obtaining their consent) with account aggregators can help create credit profiles and ease the lending process.

MFIs understand the importance of technology. About 75% of those surveyed by one of the global consultancies for MFIN said they had an alliance with fintech companies. Half of them said they had core banking solution (CBS, which networks bank branches and allows customers to transact from anywhere) and customer relationship management (CRM) software.

But there is a slip between what is possible and what actually happens. E-KYC or video KYC allows us to open a demat account or a savings bank account from the convenience of our homes, without having to visit a bank. But MFIs are wary of using Aadhar after a Supreme Court ruling on privacy. The penalty for leaking Aadhar information is severe. Complying with the RBI norms for use of Aadhar cards requires due diligence of a kind that cannot be expected from a large workforce with varying levels of dedication. So voter IDs are used instead.

The reach of internet and its quality also limit the use of technology in rural areas. Another impediment is the limited acceptance of digital payments. People need to overcome the psychological barriers first. This requires a mindset change not only in borrowers but also in MFI staff. That will come with familiarity and training.

Technology, however, cannot replace group meetings which are critical for microfinance as they ensure credit discipline. It can, via videoconferencing, but that’s a long way off.