C. Rangarajan flags fewer regional rural banks as ‘a step in the wrong direction’; urges RBI to incentivise SFBs

The fundamental concept of financial inclusion aims to provide access to basic financial services to vulnerable and low-income groups at an affordable cost. The institutional framework for this includes Regional Rural Banks (RRBs), Local Area Banks, and Small Finance Banks (SFBs). Rangarajan's critique centres on the consolidation of RRBs, driven by the government's 'One State-One RRB' policy aimed at improving operational viability and achieving economies of scale. However, this consolidation risks diluting the unique 'local feel' and specialised regional focus that RRBs were designed for. Furthermore, while SFBs have successfully targeted niche markets and the unbanked sector, they operate under stringent regulatory requirements similar to universal banks (banks offering comprehensive financial services), which disincentivises new entrants. The Reserve Bank of India faces the challenge of balancing regulatory rigor with the need to foster institutional diversity for effective credit penetration.

The article touches upon a recurring governance challenge: the reliance on creating new institutions to solve complex socio-economic problems without addressing underlying structural flaws. Rangarajan rightly points out that institutional proliferation is ineffective unless accompanied by appropriate mandates and operational freedom. This highlights the importance of institutional capacity building and effective implementation over mere structural changes. The transformation of Self-Help Groups (SHGs) serves as a key example. Originally conceptualised as grassroots, community-driven microfinance mechanisms, SHGs are increasingly being co-opted as delivery vehicles for government schemes. This shift from autonomous, capacity-building entities to mere instruments of state policy can undermine their core objective of empowering the poor, particularly women, through self-reliance and collective action.

The evolution of rural credit delivery systems directly impacts social equity and poverty alleviation. The original rationale for Regional Rural Banks and Small Finance Banks was to address market failure in rural credit, where commercial banks were often reluctant to lend due to high transaction costs and perceived risks. By catering to priority sectors, including agriculture, micro-enterprises, and weaker sections, these institutions play a crucial role in reducing economic disparities. The concern that consolidated RRBs might eventually merge with universal banks suggests a potential regression towards a centralised banking model that historically neglected rural and marginalized communities. Ensuring adequate and accessible credit through specialised, locally grounded institutions is vital for sustaining rural livelihoods and promoting inclusive growth.