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THE present study focused on the economic analysis of financial inclusion by formal financial institutions in Karnataka. The primary data was collected from 120 farmers based on their landholdings, which comprised 30 each from the marginal, small, medium and large landholdings. Secondary data was collected from State level bankers committee, Karnataka. The descriptive statistics, principal component analysis, regression and garret ranking were used to analyse the data. The results indicated that most of the districts of Karnataka were having average performance with regard to financial inclusion (FI index between 0.13 - 0.27), whereas, seven districts were having better performance (FI index >0.27). Eleven districts were performing poor (FI index <0.13). Majority of the marginal, small, medium and large farmer households were having access to bank account to the extent of 90, 90, 93 and 100 per cent, respectively. The average credit availed by marginal, small, medium and large sized holdings was Rs.32,294, Rs.44,167, Rs.1,12,600 and Rs.1,31,200, respectively. The formal source of credit constituted more than 60 per cent in all the categories of farmers. Among the components of transaction cost involved in availing credit, enforcement cost was higher than contractual and information cost in all credit sources. Cost involved in availing credit was more in informal sources than formal sources. Establishing more rural bank branches, promoting SHGs, employing more business correspondents and business facilitators, extending consumption loans and maintenance of transparency are the measures to be taken to improve financial inclusion and reduce transaction cost involved in availing credit. [ABSTRACT FROM AUTHOR]