Establishing community banks

Establishing local banking services
Village banking
Actualizing local financial services
Obtaining local banking services
Localizing needed financial services
Most savings facilities and loans to the poor come through informal finance, particularly from family and friends but also from money-lenders and pawn-brokers and saving and loan associations. Informal financial agents know their clients better than formal banks do, which reduces information costs; but despite their popularity and potential, most informal finance arrangements have limitations. They are segmented from larger markets, which reduces competition and limits their ability to mobilize resources. Quasi-formal alternatives may give greater scope for expansion. Over the last 10-15 years, a number of quasi-formal programmes have given poor people access to financial services and therefore facilitated resource mobilization. Certain characteristics of the quasi-formal finance seem to appeal to poor people: (a) low transaction costs; (b) the immediacy of deposit and disbursement; (c) the lender's willingness to extend small loans; (d) flexible repayment schedules because the financier is familiar with the borrower's situation. Unfortunately, governments tend to be wary of the informal sector, which they see as undermining both financial sector policies and monetary policies. In general, interest rates and credit availability in the informal sector tend to respond to aggregate monetary policy in the intended direction, as strong links exist between the two sectors.

The main advantage of the informal sector -- its lower transaction costs -- results from the specialization in small loans and clients. The lower costs can also be attributed to absence of legal reserve requirements and to the minimal regulation in relation to those in the formal sector. Informal entrepreneurs' lower costs may result from such factors as not paying pay-roll taxes, observing minimum wage regulations, disregard of building standards, sanitary regulations, property taxes, etc.

Group finance has evolved in many developing countries into an important form of informal credit through the pooling of savings deposits to generate funds for lending to members, or sometimes to non-members as well. It provides access to credit for group members and also the incentive and means to save in financial assets. The funds are sometimes deposited in formal financial institutions. These groups are found in both rural and urban areas of lower-income developing countries. Some fall into the category of rotating savings and credit associations (ROSCAs). ROSCAs are found in every continent. They are known by various names: contribution club, slate, mutual lending society, pooling club, thrift groups, friendly society, rotating credit association, temporary loan association and tontine. The expansion in the practice as well as in the types of ROSCAs definitely points towards a lack of - and therefore a demand for - two forms of economic system: (a) a simple and convenient outlet for savings; and (b) a convenient meeting point between deficit and surplus units, which provide attractive yields to surplus units.

Credit programmes for the poor have generally been set up on the assumption that the poor cannot pay the real cost of credit and that the poor cannot save. Accordingly, credit schemes have involved subsidized rates of interest and there has been a tendency to create solely credit programmes instead of offering a viable arrangement that would enable the poor to accumulate savings as well. These schemes have also been characterized by an orientation towards social welfare in terms of staff skills and attitude. In other words, the poor have been seen as "beneficiaries" rather than "clients". While there are understandable reasons for this approach, experience shows that it has not been particularly effective as recovery rates have been generally low, and mobilization of savings have also been low. This approach delayed the development of a commercial or a cost-effective method of credit delivery and has led to a rapid depletion of the value of loan funds. A more commercial approach to the provision of credit and mobilization of savings would tend to provide financial services that meet the needs of the poor, have good recovery, mobilize savings and become sustainable. Examples of successful projects such as the Grameen Bank (Bangladesh), the Bank Rakyat (Indonesia) and Predom (Bolivia) all illustrate that the quasi-formal commercial approach can be effective. Experience shows that although subsidy exists, as in the case of Grameen, borrowers could pay a rate that would make the bank profitable. The recorded recovery rate of loans is one which regular banks in Bangladesh, where the average rate of default is particularly high, have never approached. Moreover, evidence indicates that substantial savings can be generated by the poor, including, [inter-alia], through "forced" savings, such as deductions on loans, as in the case of the Grameen and Predom Banks. These small loans have proved to be very effective in reaching the poor.

The Grameen Bank was set up by a Bangladeshi economics professor in order to lend money to the poorest of the poor -- enough for some hens, or the cow or rickshaw which can make them independent. The initiative was taken because conventional banks had been ignoring the needs of Bangladesh's 80% poor and illiterate, because they were said to be "bad risks". The bank operates on foot or on motor scooters around the villagers. It has been enormously successful, with payback rates of 98% (compared with 90% for Western banks lending to well-off middle classes). It has been copies all over the third world, and now in Western cities like Chicago and Birmingham.

The mission of the Foundation for International Community Assistance (FINCA) is to support the economic and human transformation of families trapped in poverty through the creation of Village Banking groups. These are peer groups of 30 to 50 members-predominately women- who receive three critical services: (1) working capital loans to finance self-employment activities, (2) an effective mechanism for promoting family savings; and (3) a community-based system which provides mutual support and encourages self-worth. FINCA launched the first Village Banking programme in 1984.

In future the question will not be "are people creditworthy", but rather "are banks people-worthy".
FINCA International
Type Classification:
D: Detailed strategies