A recent article in the Economist notes approvingly about the growing phenomenon of Village Savings and Loans Association (VSLA) as a means for low-income clients to save securely and earn high returns. In brief, the mechanism entails a group, typically at a village level, pooling their savings together and lending out of this corpus to each other. The underlying principle is similar to that of chit funds and ROSCAs.
This whole design of VSLAs is missing a very fundamental point about the way in which savings operates and the value of financial intermediation. When an individual saves with an institution, she takes risk on the solvency of the institution (unlike in credit where the institution takes risk on the individual/borrower). She should be able to withdraw her savings at any time which in turn entails that the savings has been channelled and managed in a way that enables the institution to honour this. A VSLA tries to replicate this at the level of a village/community. Now imagine there is a drought in the village and there is a widespread need for liquidity. The savers will want to withdraw their money, but equally the borrowers will find it a hard time to make their repayments. Both groups are impacted by the same event (a covariate shock). Effectively, there will be a “run” on the VSLA. The VSLA, unlike a bank faced with a similar situation, does not have the diversification or the deep pools of capital to simultaneously bear the default and honour the savings withdrawals.
There is no question that access to traditional savings accounts is hard for low-income clients in all countries and innovations like the VSLAs are well-intentioned attempts to address that. However, we need to ensure that the financial inclusion designs we choose to scale do not end up creating newer types of systemic risk. The Business Correspondent approach, despite several tactical challenges, scores very highly on this count – it leverages the access of village level institutions/agents but the savings is channelled into the formal financial system through a bank.