Village Banking

Making financial services more friendly for the poor

Village banking focuses on serving the neediest and hardest to serve clients in the microfinance universe: very low-income people, almost all women, many of them living in rural areas. For these clients, village banking strives to offer microfinance plus a broader package of services than usual, not only to meet the financial needs of microentrepreneurial women but also to empower them by putting the management of special accounts in their hands.

New findings in Latin America reaffirm that village banking serves rural poor women effectively with credit and savings, but the conventional best practices require greater flexibility to respond better to clients, says Glenn Westley, senior advisor in the Micro, Small and Medium Enterprise Division of the Inter-American Development Bank.

Using a particular type of solidarity group methodology, village banking offered by 47 microfinance institutions now serves 410,000 clients in 11 Latin American countries with a combined total portfolio of $61 million. Village banking clients outnumber the 350,000 borrowers served by solidarity group lending in the region.

Village banking is a set of services that can be provided to poor clients by a variety of microfinance institutions—regulated banks, credit unions, rural banks and non-regulated non-governmental organizations—that cater to microenterprises. Services provided by village banking include not only credit but also savings, and informal education programs covering basic business skills and sometimes health care instruction or examinations. One of the most unique features of village banking is the creation of the "internal account," a limited amount of loan funds and savings that is administered by the solidarity groups and serves as a mechanism of empowerment for the clients who make decisions on its use.

One of Everything

Solidarity groups for village banking usually have between 15 and 30 members, and the group members form a village bank, adopt bylaws, elect officers, receive savings deposits and approve loans and record all transactions, says Westley. The local village bank receives a loan from the village banking institution, and the bank members guarantee the loan as a group. If the group defaults, usually all VBI services are suspended. In four leading Latin American VBIs studied by the IDB, bank members are required to save between 10 and 32 percent of the amount borrowed. The savings serve as cash collateral for the loan made by the VBI. At regular meetings, the solidarity group members make loan payments, disburse credits and receive or pay out savings. The groups may also participate in informal training in business skills or in health, childcare, nutrition and reproductive health.

The average loan for village banking clients is $150, a clear demonstration of the ability of village banking to reach down to very low-income clients. By contrast, the average loan for conventional solidarity group members is $329 and for individual loans it is $980.

The working style and services of village banking are particularly well adapted to serving the poor and clients in rural areas, say Christopher Dunford and Beth Porter, of Freedom from Hunger, a U.S. NGO that has helped launch village banking for poor women in 16 countries worldwide. Village banking staff includes field agents who go directly to the clients wherever they may be, including in remote communities, and the agents "provide service in a friendly, informal environment," say Dunford and Porter. Loans provided by village banking do not require collateral, which the poor most often cannot afford. Administration of the banking functions by the solidarity group empowers clients and participation in educational programs reinforces mutual support, reports Freedom from Hunger.

Despite the challenges of working with the poor, village banking has built up a strong record of very high loan recovery rates, good productivity of loan officers and high yields on gross portfolio. The best village banking institutions (VBIs) in Latin America have higher adjusted return on assets, financial self-sufficiency and operational self-sufficiency than the best individual lenders.

Four leading VBIs studied by the Inter-American Development Bank—Compartamos in Mexico, CRECER in Bolivia, FINCA in Nicaragua and Pro Mujer in Bolivia—illustrate the different ways in which village banking can be conducted. (In 2004, CRECER won the IDB prize for excellence in microfinance for non-regulated agencies. See related article, p. 24.) These four MFIs offer village banking services within their various institutional structures. Compartamos is a regulated MFI that does not take deposits and is an affiliate of ACCIÓN International. CRECER is an NGO that receives savings and makes working capital loans. CRECER also offers its clients participatory education in finance, business skills, self-esteem, group management, health care including infant and child nutrition, and health and family planning. FINCA Nicaragua is an NGO, the largest of the Latin American affiliates of FINCA International, and offers financial services only, credit and savings. ProMujer Bolivia is an NGO, the largest affiliate of the ProMujer network, and provides credit and savings, as well as non-financial services such as group education and individual counseling in business development, family planning, reproductive health, pregnancy and childbirth and primary healthcare screening to village bank members.

These four VBIs boast excellent rates of loan recovery, with delinquency ranging from 0.1–1.2 percent of loan portfolio; CRECER and Pro Mujer both have a loan delinquency rate of 0.1 percent. The banks are able to maintain outstanding loan repayment while reaching a very large clientele, the smallest being FINCA Nicaragua with 29,000 clients and Compartamos with 145,000 clients. Their outreach varies from between three and 10 times more clients than the average VBI in Latin America, which typically serves about 10,000 clients. The client base of the four VBIs is overwhelmingly female—women make up between 95 and 100 percent of borrowers—and poor, as indicated by the average loan balances: $109 for FINCA Nicaragua, $143 for Pro Mujer Bolivia, $145 for CRECER and $298 for Compartamos, which operates more in semiurban areas.

The Missing Element

Village banking practices imply a number of rigidities that are disadvantageous for clients, says Westley.

The terms for loans are identical for all group members, who must begin their loan term on the same date, make amortization payments at the same intervals (normally weekly or biweekly) and complete repayment on the same date. A uniform maximum loan amount is applied to all members, regardless of the differing needs of their businesses or their capacity to pay. The cap on loan amounts is usually tighter than the maximum limits on individual loans with MFIs. Forced savings for all members, often a high proportion of the loan amount, is very unfavorable for clients. Forced savings, in effect, impose a limit on investment funds or working capital for microenterprises because they freeze resources that the client could be using for building her business.

The original rationale for applying the same loan term and repayment schedule to all group members was to reduce administrative costs of village banking and increase the productivity of loan agents. Growing evidence in Latin America shows that MFIs that make individual loans are able to outperform VBIs in efficiency, or the number of borrowers per loan officer. This means that the most important advantages of the VBI methodology are to offer savings services and non-financial services as well as to facilitate networking and empowerment, says Westley.

For clients, village banking places additional demands that are not made in individual lending programs. Every week or two, village banking clients must travel to and attend lengthy meetings, and the clients must bear the risk of providing a solidarity guarantee for the group loan.

Client retention for the leading VBIs is strong, but is lower than the average for the MFI industry overall. The client retention rate for FINCA Nicaragua is 62 percent and for Pro Mujer is 65 percent. For Compartamos, the overall retention rate is 92 percent, but this includes not only VBI borrowers but also a much larger number of individual clients. (Retention figures for CRECER are not available.) By comparison, the average client retention rate for more than 15 Latin American affiliates of ACCIÓN International is 73 percent.

These findings show the need for increasing flexibility and improving responsiveness to clients, says Westley. Given the solvency and sound performance of VBIs working with the poor women in rural areas, there is room for adopting new best practices.

An important change would be to raise the maximum loan amount and to reduce the period for clients to build up a repayment record before being able to borrow the maximum amount. CRECER and Pro Mujer Bolivia should relax their stringent requirement that the client repay six and nine loan cycles of four to six months, respectively, to qualify for a maximum loan, suggests Westley. "Clients with dynamic businesses are held back for years," he cautions.

Forced savings can also choke business growth. VBIs can analyze their solidarity groups' repayment record and when it is good, could cap the forced savings balance at 10 to 20 percent of the amount the client has borrowed in the current loan. By making a risk analysis of each VBI client, the bank could come up with a sliding scale that would allow clients with strong repayment histories to put up only 5 percent in forced savings; those with reasonable credit records to put up 10 percent of the loan amount and those with weaker repayment histories to deposit 15 or 20 percent in forced savings, says Westley. Greater flexibility in forced savings would give clients more working capital for developing their business, and those who wish could channel some of the freed-up funds into voluntary savings.

More choice is needed in loan terms. Repayment frequency can be changed from weekly to biweekly, reducing the time clients must spend in meetings and increasing the productivity of loan officers. Repayment periods should be made flexible to allow clients to choose either a longer-term loan with lower payments or a shorter-term loan with higher amortizations.