Around 700 million Indians lack access to formal banking. Despite years of sustained economic growth and government initiatives, they rely on informal credit sources, such as 'chit funds,' to make their dreams come true.
"It's been a long time dream of mine to start something of my own," said Praveena Keerthi, a mother of two from Hyderabad. "I was a career woman before marriage and for sometime after, but when the kids went to school I didn't know what to do. So I thought, 'Let me become my own boss.'"
In India, women are a large part of the informal work force in both rural and urban areas. Yet many, like Praveena, lack their own credit history, making it difficult to obtain private loans. Manmohan Singh, India's prime minister and former finance minister, is urging the central bank to pass an executive order that will fast-track bank licensing in rural areas.
But Praveena isn't willing to wait for banking regulations to play catch-up. Instead she, and many others like her, have turned to a social form of lending called 'chit funds.'
More Kickstarter than Kiva
Chit funds are centuries-old Indian monetary transactions in which a number of people group-source loans. Each member periodically contributes to the pool and, in turn, is able to collect the pot as their loan. Usually the pool is made up of family members or friends.
"This business is for the middle class," said Naga Parameswari, a full-time economics professor and manager of an informal chit fund in Hyderabad. "For example, one woman is trying to pay for her son's marriage next month. She can't ask her relatives or friends, and she can't go to the bank. So she's come to me to borrow money. I'm helping her, but not just by giving her money. I'm also making a commission."
With three-quarters of the country's population living in more than 600,000 villages - and most below the poverty line - the government's biggest challenge has been to make its financial and capital markets more inclusive. That would enable people who have thus far relied on the informal sector to get access to secure forms of credit - and boost financial growth. However, tedious paperwork and legal restrictions make it almost impossible for those without a solid credit history to get bank loans.
Praveena is one of them. She took out a loan through one of Naga's chit funds and used it to open a small women's convenience store with her cousin. She said chits were the most comfortable option for her.
"I would always choose a chit over a commercial bank," she said. "The main reason is the access to the chit fund company. Even if you go to a bank asking for a loan, after fulfilling everything they ask for, they may not give me that loan. Whereas with a chit, I know my turn will come, and I'll definitely get my money."
"The issue is timely credit delivery to those who need it at the lowest cost with an infrastructure that is inexpensive to maintain," said Professor PC Narayan of the Indian Institute of Management in Bangalore. "If India is going to develop in a macroeconomic sense, the poor must have easy access to credit and the propensity to save as well. That's the channel the government wants to build."
One of the government's most promising policy initiatives is its National Rural Employment Guarantee Act of 2005 (NREGA). Through the act, every person under a certain wealth level lacking a reliable income stream is eligible for government employment for 100 days at a rate of 135 (1.96 euros, $2.56) rupees per day. The money is deposited directly into a bank account thus creating a credit history for them and also giving them the incentive to continue saving.
But the NREGA hasn't penetrated the rural areas due to infrastructure problems. Collection of payment becomes a problem since nearly 90 percent of the country's villagers still don't have access to bank branches. More than half of them continue to borrow from informal sources - namely chit funds.
"The upside is liquidity and easy availability to credit," said Narayan.
The lasting value of chit funds, particularly in rural areas, is in its laid back approach to credit delivery. Those looking to take out a small loan don't have the constraints of logistic formalities which private banks require.
"For businesses as small as mine, banks are a big thing," said Praveena. "I get scared even thinking I'm going for a bank loan. People have this perception that bank loans are for big industries. Chit funds are more between friends. Mostly run by people you trust, family members or close friends."
The major risks in chit funds lie within their strengths. Due to the culture of trust and reliability, there is no guaranteed way to secure one's savings beyond a promise. If one person in the group decides to collect their portion and disappear, there is no way to recover those lost funds.
"The government is pushing people to put money in the banking system because it's the safest way to keep your savings intact," said Professor PC Narayan of the Indian Institute of Management in Bangalore. "The key to [giving everybody access to financial services] is creating a savings environment. The key is to make sure they become bankable customers. That means creating a savings track so that you can borrow from the same institution."
Narayan says India's formal banking sector is in the best position to create a savings and credit environment which will benefit people on all levels on income. Financing tools such as chit funds, however, are too volatile to be fully scalable, he added.
Still, he doesn't see them disappearing any time soon.
"We're not for a moment saying once people have bank accounts all other channels will be irrelevant," he said. "They will continue to exist, which is good for the country because we need multiple credit delivery channels."
Better than banking?
For Praveena, the chit fund was the tool to becoming a small business owner.
"It helped me when I needed it the most. [Chits] are one thing that has made it easy for me to transform dream into reality. If I had to depend on my savings, it would take three to four years. Chits are like a catalyst to make it happen fast."
Now that their business is established, Praveena and her cousin have begun making plans to expand.
"It's good to have something of my own," she said. "Obviously the money isn't as much as I used to make, but never mind that - it's mine. It pushes me to become more than just a mom changing diapers all day. I do that too, but apart from that I'm something more, and that matters."