Changing Facets of Indian Rural Credit Market


Professor: Sougata Roy

Area of Specialization: Finance and Economics


Rural India is home to 70% of the nation’s population. The rural population resides mainly in villages — the 2011 census reports roughly 800 million people living in more than 600,000 villages. Although most of rural India’s workforce remains primarily involved in agriculture, a cumulative process of diversification through increasing importance of non-farm activities has been taking place in recent decades. This rural economy contributes about 25 – 30 % to the country’s GDP. As India strives to become a $5 trillion economy, there is a need to revitalize the rural economy, and a significant aspect in this regard is access to credit. Since independence, the government has been continuously trying to ease the availability of credit and its effective usage. However, the rural credit market has been associated with the problem of credit rationing and interlinkage of credit contracts with the input-output market.
The asymmetrical information framework, interest rate fails to clear the market and results in equilibrium with credit rationing when screening and monitoring borrowers become too costly, lenders start engaging in loan-size rationing (Gonzalez-Vega, 1977). The second aspect, i.e., the interlink age of credit with other contracts was explained by Bhaduri (1973) in terms of reduction in transaction cost and exploitation of weaker agents by powerful ones. He further argues that this linkage act as an obstacle to technological innovation. It is always difficult to serve clients who are widely dispersed, make a large number of small transactions, and operate in industries that are highly volatile in terms of price, income, and yields. As a consequence, it becomes virtually impossible for policymakers to allocate credit following prior plans. Despite these difficulties governments in developing nations have an important role in aligning rural credit markets, resolving market imperfections, and designing pro-poor policies that address the concerns of credit rationing Indian rural market indicates that the poor peasants are compelled to substitute their mortgage requirement with future shares from their harvest, which is itself subject to risk. The lenders run a high risk of loss on their loanable funds. In such a situation providing institutional credit to these poor farmers only results in subsidization of lenders. Shah et al. (2007) noted that the problems faced by the rural population in India throughout the twentieth century have continued to remain the same. Rural India has been vulnerable to shocks, both ecological and market induced. The government in the post-independence period has undertaken several policy initiatives and reforms to ease the of credit and its efficient usage.
The decadal AIDIS reports suggest the supply of credit to the rural market saw significant policy intervention during the 1970s and 1980s because the policymakers thought that government-sponsored concessional credit would stimulate production and help eradicate
poverty. However, post liberalization these institutions started to consolidate costs and reduce risk by reducing their exposure to rural financial services to improve profits resulting in the fall of their share in rural credit.
In particular, the post-liberalization phase has witnessed a decline in the rural branches of formal banks (Ramchandran and Swaminathan, 2005; Shetty, 2005) indicating a reduction in banking facilities for the rural populace of the country. Further, the National Sample Survey Organisation (NSSO, 2005) shows that the period between 1991 and 2001 was characterized by a decrease in the share of formal loans in household borrowing vis-à-vis loans from informal sources such as private moneylenders.
The importance of credit from informal institutions in the context of the Indian rural market cannot be ignored. Informal lenders such as landlords, agricultural moneylenders, and professional moneylenders provide more flexible and more desirable financial services than that provided by formal lenders. Moreover, informal loans are no more costly than formal loans when the transaction cost and opportunity cost are taken into account. For these reasons, the rural population’s reliance on informal agencies started increasing from 1990 onwards. 2002 to 2012 saw the emergence of microfinance as a significant player in the rural credit market in India and resulted in their inclusion as a new category amongst the other existing institutional agencies. The most successful model for microfinance in India has been the SHG Bank Linkage Programme which requires the SHG members to first mobilize savings to be eligible for credit from banks (Namboodiri and Shiyani, 2001). The success of the microfinance program suggests that given an adequate opportunity and incentive to save rural people can save, thereby improving their repayment ability. In 2012, microfinance institutions, which --- financial institutions associated with micro-lending including the MFI NBFC and the SHG Bank linkage programs constituted about 2.2 percent of the credit disbursal. This has risen to 5.9 percent in 2019. It is this category of formal institutions, which has more than doubled its share of credit disbursal. 
The commercial banks including the regional rural banks and also witnessed a sharp increase in their share particularly driven by the government initiative of the objective of "Pradhan Mantri Jan-Dhan Yojana (PMJDY)" is to ensure access to various financial services like availability of basic savings bank account, access to need-based credit, remittances facility, insurance, and pension to the excluded sections i.e., weaker sections & low-income groups. This deep penetration at an affordable cost is possible only with the effective use of technology.
In addition, the beneficiaries would get a RuPay Debit card having inbuilt accident insurance cover of र 1 lakh. The plan also envisages channeling all Government benefits (from Centre / State / Local Body) to the beneficiaries' accounts and pushing the Direct Benefits Transfer (DBT) scheme of the Union Government. Technological issues like poor connectivity and online transactions will be addressed. Mobile transactions through telecom operators and their established centers as Cash Out Points are also planned to be used for Financial Inclusion under the Scheme. Also, an effort is being made to reach out to the youth of this country to participate in this Mission Mode Programme.
Increased access to formal credit is a positive development
Share of rural credit by source (all India):

Credit Agencies



















Non-Institutional Agencies

















Note: All figures in percentage Source: Author’s compilation based on NSSO reports of 59th and 70th round and Lack of a bank branch in some rural parts of India is one challenge that is faced by those who already have an account. 
Aadhar-enabled Payment system infrastructure could be a possible step towards addressing these challenges by enabling basic banking transactions, increasing the adoption of digital financial services in rural India, and bringing them into the formal financial system. 
Since demonetization, the government of India has been driving different initiatives to fulfill the financial needs of the last-mile consumer.
According to a report by the Internet & Mobile Association of India and Nielsen, rural India had 227 million active internet users, 10% more than urban India’s 205 million, as of November 2019. This has created innumerable opportunities in providing people with access to life-enhancing services. So, what exactly led to this rapid technological change amongst rural Indian citizens, and how has it improved their connection with the wider world? Unified Payments Interface is an instant real-time payment system developed by the National Payments Corporation of India. 
Smartphone penetration doubled in rural households in the past three years but a quarter of the children with digital devices at home don't have access to them, said the latest Annual Status of Education Report (ASER) survey released on Wednesday.
According to the survey, the availability of smartphones in rural India was 36.5% in 2018, which increased to 61.8% in 2020 and 67.6 % in 2021. And at least 27.9 % of households in rural India bought a new smartphone for their children’s education this year. This figure was 9.1% last year.
Other concerns – 
In nominal terms, from Rs 500 in 1971, the AOD per household rose to Rs 32,522 in 2012. The decadal growth rate was 65.32 percent in 1991, which has increased to 76.82 percent by 2012.
A sharper rise in rural indebtedness. Incidence of indebtedness has increased by 4 percentage points among rural households § Outstanding debt has risen by 84% among rural and 42% among urban households, on average
The average outstanding debt per household is ₹32.5k to ₹59.7k
The coronavirus and a lockdown aimed at stopping it last year saw millions of people thrown out of jobs in cities and towns and forced back to their villages, and ever higher levels of debt.
Big debt and low income in the countryside will hold back any economic recovery the government is trying to generate and also dent private savings and investment for longer than expected, economists say. It will have a huge impact and prolong the recovery process. Private consumption and investments both will be hurt. There is merit in finding ways to put money in the hands of the people," said N.R. Bhanumurthy, economist and vice chancellor at Bengaluru-based B.R Ambedkar School of Economics. Borrowing has risen by three times since the pandemic hit in March 2020 and about half of that was taken out in the past six months, the survey found. The major gap in the availability of formal credit to cater to medical emergencies and fund household-based micro-enterprises Out-of-pocket health Expenditure (about 10%).
Therefore, even though the financial assets have increased, a major part of the credit is getting diverted to non-income generating activities. The expenses of housing (20.5 percent) and medical requirements (6.1 percent) constituted the bulk of credit usage in 2012. The expenditure on repayment of debt also registered a marginal increase from 2 percent in 2002 to 2.6 percent in 2012. This is not a healthy signal. With a higher proportion of funds being utilized in non-income generating avenues, the distress level of the borrowers are going to increase further in the future. Such a situation is attributed to the “fungibility” of credit which means that one unit of money, be it owned or borrowed, is just the same as any other unit of money. The money received from the loan provides additional liquidity and gets used in the most attractive avenue available from the perspective of the loan recipient. As a consequence, cheap concessional credit, provided by the institutional agencies, gets diverted towards meeting other household requirements and the policymakers can't control such diversion of credit (Von Pischke and Adams, 1980; Adams and Graham, 1981; Adams and Vogel, 1986). Moreover, in the absence of productive opportunities, repayment capacity is missing, and the enforcement of debt contracts results in the impoverishment of borrowers (Gonzalez-Vega, 2003). Fungibility also creates problems in evaluating the effectiveness of the credit program. However, there is no reason to believe that such a diversion of credit is always bad. As Von Pischke and Adams (1980) suggested, credit project impacts should be viewed in the context of the overall rural credit market performance and not merely the household or farm level performance.
Vulnerability in the livelihood of rural population and fungibility of credit results in credit being diverted towards meeting expenses related to an unexpected health scare, child’s education, or other social obligations. Managing such situations is always a challenge. However, the level of financial stress can be relieved if the MFIs direct more credit to crop enterprises or come up with inventory credit programs for farmers (Abaru et al., 2006; Baquedano and Sanders, 2006) As Shah et al. (2007) pointed out; there is a huge requirement of improving public investment and providing marketing support to improve the condition of the rural economy. The government along with donors needs to focus on long-term investments such as weather reporting stations, low-cost irrigational facilities, drought-resistant seed varieties, improved sanitation, better preventive health care, and educational facilities along with the creation of sustainable financial services which includes a thriving insurance market.
Subsidizing institutions with natural spillover and avoiding subsidies that undermine competition can prove to be highly beneficial in integrating the rural credit market.
Ray. S, (2019) "Challenges and changes in Indian rural credit market: a review", Agricultural Finance Review, Vol. 79 Issue: 3, pp.338-352,
National Sample Survey Organization (2021), All India Debt and Investment Survey, 2019, NSS 77th Round, Government of India, New Delhi
Reuters (2021, July 06). COVID-19 impact: Rural India sinks deeper into debt as household incomes slump. BunisessToday.In. Available at -
Iftikhar, F (2021, Nov 18). 27.9% rural households bought a smartphone for kids’ studies amid pandemic: Survey. Hindustan Times, New Delhi