Indigenous Banking System in India | Functions, Methods and Defects

What is Indigenous Banking System?

From the very beginning of civilization, humans have used all sorts of trading methods even though their needs were limited. Initially, people exchanged goods or other materials in turn for the items they required to satisfy their wants. This was known as the barter system. Slowly, as economic life progressed, people started using metallic coins in place of materials as a medium of exchange. The Indigenous banking system played a significant role in lending money or providing financial aid to the local members of its community. 

The term Indigenous Banking System was developed by the native or indigenous communities of a particular area or country that describes the financial customs and organisations. The indigenous community focuses on empowering the economy, promoting self-reliance and sustainable growth of the members within the community. They provide financial support to local entrepreneurs and help preserve their cultural heritage. These systems existed even before the formation of modern banking institutions and are still in use in certain rural and remote areas. It often involves informal methods of saving, lending, and managing money that has been passed down through generations. With the establishment of such a banking system, people began depositing their valuable metals with the lending parties mostly known as Seths. These bankers and seths became an instrument for supplying money for producing more goods.

Some of the prominent indigenous banking systems in India are the “Chit Fund” and “Hundi” systems. Documents such as Hundis and Chitti were used for buying and selling on credit. In the Chit Fund System, a certain amount of funds are pooled and distributed on instruction to an individual for various purposes like investment, starting a business, or personal use. Similarly, the Hundi System involves the transfer of funds from one place to another through the network of Hundi brokers in areas that have limited access to formal banking systems. These systems are often called Cooperative Credit Societies in some areas of South India. So, Hundis involved a contract that guarantees the payment of money, the promise or order which is unconditional and is capable of change through transfer by valid negotiation.

There are different types of Hundis. Some of the popular hundis are as follows:

1. Darshani Hundi: This is a type of hundi that is paid on sight. It is like a demand bill and must be presented for payment within a specific period of time.

2. Muddati Hundi: It is a type of time bill, payable after a specified period that is mentioned in the hundi. It is also known as Miadi Hundi and banks usually provide loans by keeping these hundis as security.

3. Shahjog Hundi: This is a type of hundi that is payable only to a respectable person with a financial value in the market. These holders are popularly known as a Shah. It is freely transferable but is not payable to the bearer. 

4. Namjog Hundi: It is a hundi that is payable to the person listed in the hundi.  

5. Dhanijog Hundi: A Dhanijog Hundi is a hundi that is payable to the owner, a holder, or a bearer-owner.

6. Jawabee Hundi: A hundi is referred to as a jawabi hundi if it is written in the form of a letter or suggestion to a banker for the payment of a certain amount of money to a particular individual.

7. Zikri Hundi: This is a hundi that was authorized for honor in writing on a Zikri chit (letter of protection). It is drawn in the name of a specific resident of the town or city in which the hundi is payable.

8. Jokhmi Hundi: Jokhmi is derived from a Hindi word ‘Jokhim’; i.e., risk. It is a type of hundi which is usually drawn against the goods which are shipped on a vessel. There is a certain amount of risk involved in the shipment. Besides, this hundi is payable only when the goods arrive safely at the desired location. Thus, if the goods are lost in transit, the consignor cannot claim the playment.

9. Firmanjog Hundi: This type of hundi is just the opposite of Dhanijog Hundi and is payable to the order of payee.

Functions of Indigenous Banking System

These systems, which work independently from the standard banking sector, often have special features and functions that have been designed in accordance with the needs and values of these communities. Some of these functions are as follows:

1. Advancing Loans:  Indigenous banking systems, also known as local banks, offer loans to community members consisting of local residents, firms, and farmers to meet their financial requirements, such as starting a business, buying farm equipment, paying for education, or for any other personal use. These loans are provided on trust and mutual understanding and to help meet the needs of its members.

2. Discounting Hundis: A Hundi is a traditional indigenous financial tool used for transferring funds. The indigenous banking system provides immediate cash payment to the Hundis in exchange for a discounted value. This helps in the smooth functioning of the banks concerning the transaction of money.

3. Inland Trade Financing: Indigenous banking system provides financial support to the local traders and merchants for their domestic trading, transportation, and other related expenses. To enable a smooth exchange of products and services within the community, they provide extended credit or working capital to them.

4. Accepting Deposits: Indigenous banks also accept deposits from residents and local businesses within their communities. This includes deposits in the form of both savings and fixed deposits, giving people the opportunity to protect their money and receive a return on their investments.

5. Remittance Services:  Indigenous banks offer remittance services to facilitate the flow of money between different regions or even countries. This helps people to send and receive money smoothly to or from friends and family members who live abroad.

Methods of Indigenous Banking System

There are various methods in the indigenous banking system, but some of the common methods found are as follows: 

1. Promissory Note: A promissory note is a written promise from one party to pay a specific amount to another party on a specified date or upon demand. In the indigenous banking system, the borrowers use promissory notes as a means of financial agreement in which the borrower takes their debt into account and makes a promise to repay the borrowed money.

2. Dastavez: Dastavez is a traditional name for a written document used in the Indigenous Banking System as collateral or security which serves as the terms and conditions of a financial transaction. Dastavez is used to legally secure loans, investments, or other financial agreements between individuals or groups.

3. Rohan: Rohan is a rotating savings system used in some indigenous banking systems. In this system, each member of the group takes turns in receiving the pooled amount which can be utilised either for personal or commercial needs. The rotation continues until each member has received their share of the money. The Rohan System helps community members accumulate finance, establish credit, and save money.

Defects of Indigenous Banking System

The indigenous banking system can have several drawbacks or defects. Some of the key defects include:

1. Lack of Regulation: Indigenous banking systems can operate without the required regulatory control, increasing the danger of fraud. The system might not offer depositors or borrowers enough protection due to the absence of appropriate rules and supervision.

2. Limited Access: Compared to standard banks, indigenous banks often provide fewer financial services and products such as basic loans and savings services. These systems may not be able to address the demands of a wide range of the population, excluding certain groups from financial services.

3. Lack of Financial Literacy and Consumer Protection: In an indigenous banking system, consumer protection measures and financial literacy may not be given much priority. They can be exposed to predatory practices, poor disclosure of terms and conditions, and limited knowledge about their rights and responsibilities as customers. Limited education about financial products and management can lead to poor financial decision-making.

4. Informal Nature: Indigenous banking may be informal and lack basic documents and transparency. This might often lead to threats like fraud, misuse of funds, etc.

5. Inadequate Technology: Outdated technology, manual processes, account opening, and loan processing may lead to operational inefficiencies within indigenous banks. Such issues can slow down regular banking activities. This might lead the banks to face troubles in meeting customer demands efficiently.

6. Vulnerability to Shocks: Indigenous banking systems are much more exposed to external shocks such as economic crises or natural disasters due to their restricted nature. Their incapability to deal with emergencies put them at a higher risk of financial instability and crises.

Though over the years, the importance of these indigenous systems has dropped to some extent, they continue to play an important role in supporting the financial needs of communities in certain regions of India, especially in rural areas where there is limited access to formal banking institutions.