In addition, Village Funds can borrow an additional million baht (or sometimes just half a million baht, see below) from the BAAC or other facilitator. The size of this additional loan - i.e. half a million, or a million baht - is determined by the BAAC using its own (banker's) criteria. Only Village Funds that are ranked 1<sup>st</sup> class or 2<sup>nd</sup> class by BAAC may borrow a million baht; the others (3<sup>rd</sup> class) may only borrow half a million baht. The BAAC says that about 1% of these loans are overdue. The BAAC thus rates the managerial efficiency and potential of VRF Associations and may be intending gradually to withdraw from micro-lending by giving these village funds a space for competition to run village banks. The BAAC recognizes that Village Fund Committees generally have an informational advantage in determining who is a good candidate for a loan.<sup>3</sup> Some of the more dynamic Village Funds are trying to become rural banks, which would potentially lead to an efficiency gain in that it would allow money to move from one village to another.

# **3. Measuring the Impact of the Village Revolving Fund**

The injection of loanable funds due to the VRF was substantial, averaging 2.7% of annual income, or 7.1% of income for the 38% of households who borrowed. Because a million baht was available for every village, regardless of size, the importance of the VRF declined with village size: in the smallest tenth of villages, VRF loans represented 7.9% of income, but just 1.1% of income in the largest decile of villages (Table 1). What impact might one expect from such a sizeable one-time infusion of cash?

It is not self-evident that an injection of credit into a rural economy will have a measurable impact, or a positive impact. If financial markets operate well – information is cheap and readily available, there are no policy distortions – then households should already have access to as much credit as they can productively use, and they would mainly substitute VRF credit for other sources of credit. So for the VRF to have an impact on output, it must be predicated on the existence of market imperfections. As a general proposition, this is not unreasonable, as credit markets have well-known informational asymmetries that in turn can lead to the inefficient allocation of credit, excessive loan default, monopoly profits for well-informed lenders, and even credit market collapse (Bardhan and Udry 1999, p.91). The important point is that it cannot be assumed, a priori, that the VRF will necessarily have a major impact on household welfare.

According to the Socio-Economic Survey undertaken in 2004, 24% of respondent households said that they did not borrow from the VRF because they had no need for credit, and a further 25% said that they did not borrow from the VRF because they did not want to take on more debt. We have assumed that in the absence of general equilibrium effects, the introduction of the VRF credit cannot be expected to have an

> 3 This process, however, could potentially squeeze out some existing borrowers who may have less access to BAAC loans, and yet not be able to get VRF loans for one reason or another.  Moreover, some VRFs may be inefficient for the following reasons: (i) lending to unqualified borrowers; (ii) favoring committee members; (iii) extending loans that  are larger than the limit (e.g. 50,000 baht); (iv) not insisting on repayment; (v) charging a lower interest rate; and (vi) landing for longer-than-allowed periods.

_Village Fund, draft of June 29, 2009_ _Page 4 of 34_