Summary of JOIE article ( 12 May 2021) by Rashmi Arora and P. B. Anand, Faculty of Management, Law & Social Sciences, University of Bradford, Bradford, UK. The full article is available on the JOIE website.
Recent discussions on inequality have focused on increasing global income and wealth inequality between individuals, inequality between countries and inequality among different population groups within a country. Such disparities, whether in large or small countries, can lead to increased poverty in certain regions, skew intra-national migration patterns, cause resource-based and inequality-based conflicts and militancy, as well as pose threats to national security in general. In the context of Sustainable Development Goals (SDGs), eliminating extreme poverty and hunger, reducing other forms of poverty, and promoting inclusive and sustainable human settlements are national policy priorities (SDGs 5 and 10).
Although a large body of literature exists on the above dimensions of inequalities, there is a dearth of literature on the role of financial sector in escalating or reducing regional disparities. Theoretically, well-developed financial systems can promote economic growth, remove financing constraints for firms, reduce poverty and provide new opportunities. Less developed financial systems, on the contrary, lead to entrenching of inequality, loss of opportunities to the poor, less investment in enterprise growth and low human capital development. Unequal financial development has profound implications for the rest of the economy as it can lead to regional disparities, whereas an inclusive financial development may provide more opportunities and reduce regional inequalities. Improved access to financial services and products for the households also promotes financial development, contributes to economic growth, reduces income inequality, poverty and has a positive effect on household incomes.
In this study, we examine financial development at the sub-national level in the context of, India. A large emerging economy, India serves as an apposite case; possessing a large federal economy with sub-national units (states) at varying stages of development, and a financial sector where the ownership structure is skewed and diverse. Our research questions are: how do we measure the level of financial development at the sub-national level? How unequal is the financial development across the states? Does it vary by the ownership of financial institutions? Widening regional disparities including widening rural-urban gap has been observed in India especially since 1990s.This inequality has persisted across various socio-economic dimensions.
To explore the research questions, our study develops a banking development index at the sub-national level for three different bank groups – public, private and foreign for 25 Indian states covering 1996-2015. For analytical purposes, we group states into leading and lagging. States with per capita incomes above the national average are leading, whereas those below are lagging. As a single indicator is unable to capture the full extent of financial development, we build composite banking index for 25 states for 1996–2015. We build separate banking indices for public, private and foreign banks separately. As we focus on banks and different bank groups, we only consider banking indicators and construct indices for the three bank groups separately. At the sub-national level for different bank groups and years, data are only available for credit, deposit, and population per bank branch. We do not have bank group data on other dimensions for instance, efficiency and stability of the financial system (average staff costs per branch, or non-performing assets at the state level). Nonetheless, our choice of indicators, constrained by data availability, reflects depth and outreach of banking services in different Indian states. Credit indicators include per capita bank credit; credit/state output and number of credit accounts per 1,000 people. Deposit indicators are deposits/state output; deposit accounts per capita (number of deposit accounts per 1,000 people) and per capita bank deposit. Data available on credit for each bank group relate to total credit and do not distinguish between public and private credit.
As the aggregate banking index for the period 1996-2008 shows, Maharashtra (a more developed state in the western region) has outperformed all other states followed by Tamil Nadu, Karnataka and Kerala in the southern region. During 2009–15 as well, the top four states continue to be Maharashtra followed by three southern states Tamil Nadu, Karnataka and Kerala. Overall, the position of top three and bottom three states in the aggregate banking index has remained unchanged reflecting a lack of convergence across the states, lop-sidedness of regional development and persistence in regional disparities. An interesting finding is the improvement in the ranking of some north-eastern states (Arunachal Pradesh, Tripura, Mizoram and Meghalaya) during 2009-15, though most still lag behind most other states. Population covered per bank branch (public and private banks) declined steadily in these states showing increased government emphasis on enhancing financial inclusion. We also grouped states into four categories: those with indices value <0.1, low (0.10–0.24), medium (0.25–0.49) and high banking development values (>0.5). In 1996-2008, only four states had high financial development and at least 14 states fell into low to very low banking development group. There were marginal changes during 2009-15 as states with high financial development declined to three instead of four earlier. The divergence in banking development between leading and lagging regions has in fact, increased over the years, although it has narrowed slightly from 2014 onwards and is evident across all bank groups.
Some factors leading to such disparity in financial development include institutional factors such as differences in property rights enforcement across states influencing credit allocation, bank branch location, judicial capacity. Differences in historical factors such as land regulations including land tenancy laws have also influenced several inefficiencies and persistence of informal, insecure, short-term tenancies impacting their access to formal credit. Recent drive to increase financial inclusion and financial development has remained mainly supply centric and neglects demand side barriers for instance, low household incomes leading to low demand for formal financial services, financial illiteracy, travelling costs to the bank and low education. At the same time, as our analysis showed the crucial role played by institutional factors such as historical differences in land systems across the states which has shaped and influenced economic development including access to credit of lagging states. This implies that demand alone may not be a sole barrier to accessing financial services.