Village Banking

Background and Introduction
About 70% of the nation’s population lives in rural areas and a dominant portion of the rural people is poor. Despite the fact that a dominant portion of the population lives in rural areas, formal financial institutions do not provide financial services within these areas. To these financial institutions, the income derived from these services does not warrant the cost of provision due to the limited extent of services and the remoteness of most of the rural villages. Furthermore, characteristics of the rural areas such as poor infrastructure, low population density, high levels of illiteracy, and limited business activities further restrain formal financial institutions from addressing the financial needs of the rural population. Rural villagers on the other hand, face high transaction cost in travelling to the nearest bank and often do not adhere to the minimum requirements set by the bank for either opening a savings account or obtaining a loan.

On the other hand, this is a commonly agreed reality that the rural poor need a variety of financial services to cater their diversified financial needs. The financial services rural people need or demand are as follows:

  • The safe keeping of cash and saving opportunities: Several research studies indicate that rural people have the ability to save. Often the importance of savings in rural areas has been neglected since it was assumed that rural people cannot and will not save due to low income levels and a high propensity to consume.
  • Credit: Credit is needed for several purposes. In addition to the credit demand for productive purposes, poor need credit for some consumption purposes including marriages, births and health and education needs.
  • Insurance: As an essential part of the financial services, people need insurance services to cope with emergencies and reduce the risks of any of the adverse situations.
  • Remittances Services: Extended family networks found in the rural areas and extensive rural-rural and urban-rural migration lead to the demand for better electronic transmission services. Such services will allow money transmission between urban and rural areas as well as within and between the rural areas.

In order to respond to the above-mentioned financial needs of the rural poor, innovative approaches and processes are required to be introduced that address not only the risk and cost restraints, but also fulfill the specific financial needs of the rural poor in a sustainable manner.

As an attempt to bridge to enhance the rural poor’s access to the required set of financial services in a sustainable and cost-effective manner, FFO has initiated an innovative model of ‘Village Banking Program’. The village banks are community based semi-formal financial institutions that create access to basic banking services on a sustainable basis by utilizing the community’s rules, customs, relationships, knowledge, solidarity and resources combined with formal financial methods and concepts. A bank is initiated, owned and managed by the villagers themselves.

Approach and Philosophy
The village banking program is based upon the bottom-up approach rather than a top-down. Under the bottom-up approach, target group of the microfinance is made ‘Custodian’ of resources rather than creating just a ‘Liability’ for them.

Given the financial needs of rural poor and the problems of adverse selection and some cultural and environmental hazards associated with providing these services, FFO makes use of the concept of decentralized financial services. The concept of the decentralized financial services entails that these services are primarily organized and managed by the local community itself.

Program Goal
To establish a sustainable and socially compatible financial system that is well capable of providing the tailor made financial services to the rural poor as a means to empowering them to help them.

Program Strategies
Following strategies are used to implement the program:

  • Social Mobilization and Organization
  • Capacity Development
  • Provision of the Lines of Credit
  • Monitoring, Evaluation and Research

Implementation Methodology
Under the program, Community Development Organizations (CDOs) are established and strengthened through various capacity development interventions. After gaining maturity against different indicators, these CDOs work as Village Banks to fulfill the financial needs of the rural poor. The village banks first accumulate their own financial resources through membership fees, members' savings and wherever possible, through some grants. After having built up the required level of financing at their own, they are provided the lines of credit by FFO. These lines of credit are utilized by the Village Banks to finance their village-level credit operations. Through accumulated earnings and other incomes, FFO plans to make every Village Bank sustainable in a period of three years.

An Outline of FFO’s Village Banking Model
Following is an outline of the concept and methodology of FFO’s Village Banking:

  • A village is selected for the establishment of a Village Bank.
  • Making use of the common tools and techniques of social mobilization, a Community Development Organization (CDO) is established in the village to work as a Village Bank.
  • The CDO/VB is provided technical support to evolve its structure, develop by-laws, get the legal status through registration and design procedures to work as a financial intermediary.
  • After certain interventions of CDO/VB strengthening and capacity building interventions, an agreement is signed between FFO and the VB.
  • The VB accumulates its own financial resources through members’ savings, membership fees, and grants. After a VB accumulates the required level of internally generated funds as per the criteria, FFO provides the VB a line of credit.
  • The Village Bank selects its borrowers; borrowers are selected by the VB members. FFO staff does not conduct loan analysis.
  • The VB’s Credit Management Committee (CMC) is responsible for the overall performance of the banking activities.
  • FFO keeps playing the role that of a facilitator on a continuous basis. Monitoring and evaluation process also remains an integral activity on the part of FFO.  

Some Important Implementation Modalities
Followings are some important implementation modalities including criteria, salient policies and major prerequisites:

  • After the initial assessment, a Village Bank (in the form of a CDO) is established in the selected village
  • Every VB have a General Body consisting of all the members. The general body elects an Executive Body and a Credit Management Committee (CMC).
  • The membership fee is Rs. 300
  • The minimum compulsory saving for each member is 7% of the loan required
  • The average rate of mark-up charged by the village bank is 20% (flat) per annum
  • The rate of mark-up charged by FFO to VBs is 12% (flat) per annum
  • No single loan disbursed by a VB exceeds Rs.50,000
  • The line of credit to a Village Bank by FFO is determined on the basis of the performance of a particular Village Bank. The performance is measured against a set of established indicators.

Unique Characteristics of the Village Banking
Following unique characteristics make the Village Banking a preferred model:

  • Reaches the poorest: Since village banks do not rely on collateral to guarantee loans, they can serve those lacking land or other assets
  • Places emphasis on savings:  New loan sizes are based on the previous loan size plus the amount saved in previous loan periods
  • Uses members of the village bank to guarantee loans:  Members may not get a new loan unless fellow members are up to date on their payments. Social pressure substitutes for collateral
  • Fosters a democratic process and community ownership: Village bank members participate in the decisions most likely to affect them. They create their by-laws and are given choices about their services. Because members are involved in key decisions, they feel that the village bank and its future belong to them
  • Is sustainable and able to reach scale:  Village bank loans are issued to borrowers at market rates. The interest charged covers the cost of village banks and providing services to more people. The village banking model reaches many individual borrowers through forming large groups and thus allows a program to reach an unlimited number of the rural self-employed. Reaching tens of thousands of clients is entirely possible in a well-managed village banking program.