“There are many devices for turning small savings into usefully large lump sums—the main money- management task of the poor. Most of it is done in the informal sector” (Rutherford 2009). People often borrow from or save with a friend or a rela-tive to help smooth cash flow, take advantage of an opportunity, prepare for a life-cycle event, or address an emergency. Informal groups, formed for the purposes of mutual aid or savings and credit, are also common. An early analysis of the Global Financial Inclusion (Global Findex) database 2012 reports, “Community-based sav-ings methods such as savsav-ings clubs are widely used in some parts of the world but most com-monly in Sub-Saharan Africa. Among those who reported any savings activity in the past 12 months, 48 percent reported using community- based sav-ings methods”; of these, 34 percent reported hav-ing saved ushav-ing only a community savhav-ings club (that is, not in addition to a formal account) (Demirgüç-Kunt and Klapper 2012).
Informal financial services tend to be flexible, convenient, and close to where the poor live; how-ever, they may not always be available when or in the amounts needed. As discussed in chapter 1, informal financial service providers are referred to as community-based providers (see figure 6.1).
Community-based providers offer flexible ser-vices that can accommodate uncertain cash flows and provide discipline to encourage regular sav-ings and loan payments. One of the greatest benefits of community-based providers is acces-sibility, determined by both proximity and prod-uct features (for example, minimal administra tive procedures, no collateral requirements, low trans-action costs, flexible terms) that suit the needs of poor women and men. However, limited product offerings and potential unreliability are some of their disadvantages. Somewhat more so than institutional providers (discussed in chapter 7), community-based providers are vulnerable to collapse or fraud, whether because of corruption,
Figure 6.1 The Range of Financial Service Providers
Level of formalization
Community-based providers Institutional providers
Individuals Mobile network operatorsa
Regulated institutions Deposit-taking MFIs Savings and postal banks
State banks
Commercial microfinance banks Non-bank financial institutions
Commercial insurers
Note: ROSCAs = rotating savings and credit associations; ASCAs = accumulating savings and credit associations; CVECAs = caisses villageoises d’épargne et de crédit autogérées; SACCOs = savings and credit cooperatives.
a. Mobile network operators are regulated as communication companies; most are not licensed to provide financial services.
lack of discipline, or collective shocks—for exam-ple, a natural disaster or a bad harvest (Robinson 2001). Borrowing from family and friends can also be associated with stigma or loss of dignity, espe-cially if borrowers become dependent on others or over-indebted (Ruthven 2002).
Informal or community-based financial ser-vice providers can be divided into two broad categories: indigenous and facilitated.
Indigenous providers, both individuals and groups, emerge within communities with no external input or training. Individual providers such as moneylenders generally offer basic credit services using their own capital. As local residents, they offer convenience and a rapid response. Indigenous groups are different;
their most common goal is to combine small sums into bigger ones, the purpose of which varies with the type of group. A rotating savings and credit association (ROSCA) pools money to circulate among the members in turn, while a mutual aid society pools member contributions to have funds available to respond to unex-pected or emergency expenses (often a specific
type of expense, such as a funeral). Group members determine the rules that govern the group.
Facilitated providers are groups (not individu-als) that receive external training or assistance, typically provided by nongovernmental organiza-tions (NGOs) or government, to develop and implement a process for saving and lending. Many forms of facilitated groups have been introduced over the years, but perhaps the largest, most well-known are India’s Self-Help Groups (SHGs).
Most facilitated groups follow a set of procedures designed to help them to save regularly, pool their savings, and make loans. Some operate solely within their community; others federate, borrow from banks to on-lend to their members, and take on other development activities in addition to financial services. Despite their diversity, facili-tated groups serve people who typically may not have access to other financial services. They have a relationship with an external facilitator (often time-bound) that introduces an approach or model with procedures and systems to guide their financial activities.
Indigenous Providers
Individual indigenous providers include money-lenders, deposit collectors, informal traders, pawn-brokers, store owners, and informal money transfer providers. Some traders, processors, and input suppliers also operate informally, while others are more formal in nature (and thus are discussed briefly in chapter 7 as well). Indigenous groups include ROSCAs, accumulating savings and credit associations (ASCAs), and burial societies. Table 6.1 summarizes their key characteristics.
Individual Providers
Family and friends are the most common providers of financial services in the informal sector in all developing-economy regions, but especially in Sub-Saharan Africa, where 29 percent of adults report friends and family as their only source of
loans (Demirgüç-Kunt and Klapper 2012). In addi-tion to personal relaaddi-tions, individual community- based providers such as moneylenders or shop owners are common and operate either as licensed providers or completely informally.
As part of the local community, moneylenders are not only easily accessible to borrowers, but often have personal relationships that enable them to evaluate the borrower’s repayment capacity. These factors allow for fast transactions in locations convenient to the client. However, moneylenders can be very expensive. For exam-ple, in many countries a standard loan from a moneylender is a “5/6 loan”—that is, for every five units borrowed, six must be repaid. This amounts to a periodic (daily, weekly, monthly) interest rate of more than 20 percent (Helms 2006). Individuals are often willing to pay high prices in exchange for receiving cash quickly and
Table 6.1 Characteristics of Community-Based Financial Service Providers: Indigenous Groups
Characteristic
Individual
(money lenders, deposit
collectors, traders) Money transfer (hawala systems)
Community-based groups (ROSCAs, ASCAs, burial societies) Legal form No formal legal form;
adhere to local customs;
sometimes registered
No formal legal form, adhere to local customs;
sometimes registered
May be registered with local authorities or community leaders Regulation and
oversight Typically not regulated;
sometimes local oversight or registration
Not regulated Not regulated
Ownership Owner operated Owner operated Member owned
Governance Self-governing Self-governing Self-governing; sometimes an elected committee Target market Poor and very poor needing
credit or a place to save Poor and very poor needing quick and accessible transfer services
Poor and very poor needing small amounts of credit and a safe place to save frequently
Products Basic credit and savings;
contractual savings with some collectors
Informal money transfer across geographic distances
No capital costs; user fees to cover operating costs and profits
Funding Own capital; interest and fees collected to cover operating costs and profits
No capital costs; user fees to cover operating costs and profits
Member contributions or savings; sometimes external borrowing; interest and fees (no operating costs)
basis, while money guards generally expect clients to come to them (see box 6.1). Collection normally occurs over a specified period of time, after which the depositor’s savings are returned net of fees. Fees are charged either as a percent-age of the amount deposited or as a flat fee per deposit. Research shows that the amount charged is similar to the total cost, direct and indirect, of depositing directly with a bank or saving in real assets (Ashraf, Karlan, and Yin 2006). Clients may use deposit collectors for various reasons, including convenience, lack of connectivity, or cultural restrictions. Deposit collectors provide structure to accumulate sav-ings, offering both safety and discipline. Saving with a deposit collector is not without risk, how-ever, as clients may not be able to access funds when needed or the collector may disappear with their savings.
Shop owners sometimes hold cash they receive from clients who want it out of the house; they also often provide credit to trusted clients who take goods “on credit” and pay for them at a later date.
Especially in agriculturally dependent rural areas, traders may be important sources of infor-mal credit for farmers. For example, credit may be extended to purchase raw materials with the promise that they will sell the product back to the trader.
conveniently, particularly in an emergency when there are no other options.
Pawnbrokers are also characterized by a high volume of small advances made for a relatively short period. In contrast to most moneylenders, pawnbrokers take physical possession of collat-eral when lending. In some countries this practice has become more formalized, with rules, standards, and registration required. Loan amounts are normally significantly smaller in value than the collateral pledged. Given the necessary processing, valuing, and storing of collateral, a pawnbroker’s transaction costs may seem high given the small amounts borrowed.
These transaction costs, however, are partly off-set by the fact that the pawnbroker does not take time to evaluate the borrower or monitor the loan (Skully 1994). Loans are made strictly on the basis of collateral, which can be sold to recover the loan amount (most pawnbrokers also operate a retail store to sell goods that are not collected).
Deposit collectors or money guards—people who collect and store savings—are common-place in the developing world. They offer a con-venient way to put cash safely out of reach without having to spend money and time on travel. Deposit collectors travel to their clients, visiting their homes or businesses to collect a predetermined amount on a daily or weekly
Box 6.1 Ghana’s Susu Collectors
Ghana is home to a large number of susu col-lectors in the informal sector who go door to door collecting savings for a fee, mostly from female market vendors and microentrepre-neurs. Susu collectors have an average of 150–200 clients and collect deposits at homes within the village on a daily or weekly
basis. The susu club is a variation on this col-lection system, wherein members go to a designated place on a scheduled day of the week to deposit their savings with the susu collector, who uses the group format to ser-vice a much larger number of clients.
Source: Gallardo 2001.
because they are discreet and involve little to no paperwork. They are also more accessible, espe-cially for those without documentation in the sending country, and may seem more trust-worthy because they are underpinned by per-sonal relationships (see box 6.2).
Individual providers in the informal sector offer advantages associated with operating inside the community, including accessibility, conve-nience, small transactions, and familiarity. They provide direct cash-in, cash-out services, with all transactions taking place on a personal basis usu-ally right in the village. This makes transaction costs relatively low, although the price of ser-vices is normally quite high. As individual pro-viders are often the only option available, the poor are forced to accept both their costs and risks, including theft and fraud. Association with While credit and savings are the most
common services associated with individual providers in the informal sector, money transfer providers—individuals specializing in transfer-ring money from one person to another—offer a fast, usually safe, and cost-effective way to trans-fer funds domestically and internationally.
Informal fund transfer systems vary in structure and complexity. Hand carrying cash, usually by migrants who are often family or friends, is the most basic system and especially common in situations of seasonal or circular migration, when migrants frequently return to their homes.
Internationally, cash is physically transferred by couriers; domestically, it is transferred by bus companies and taxi drivers (Isern, Deshpande, and Van Doom 2005). Many senders and receivers prefer informal transfer mechanisms
More sophisticated informal systems exist under different names around the world, including hundi (South Asia), fei-chen (China), hui kwan (Hong Kong SAR, China), padala (the Philippines), phei kwan (Thailand), and hawala (the Middle East). Many of these systems, such as those common in African mineral- exporting countries like Angola, evolved as mechanisms for financing trade and transfer-ring net funds against the movement of goods.
The hawala system used in the greater Middle East is representative of how such systems work. Typically, a migrant makes a payment to an agent (hawaladar) in the coun-try where he works and lives, and the hawaladar provides a code to authenticate the transaction. The hawaladar asks his counterpart at the receiving end to make
the payment to the beneficiary upon sub-mission of the code.
After the transfer, hawaladars settle accounts through payment in cash or in goods and services. They are remunerated by senders through a fee or an exchange rate spread. Hawaladars often exploit fluctuations in demand for different currencies, which enables them to offer customers better rates than those offered by banks (most of which only conduct transactions at authorized rates of exchange). Since many hawaladars are also involved in businesses where money trans-fers are necessary, such as commodity trading, transfer services fit well into their existing activities. Remittances and business transfers are processed through the same bank accounts, incurring few, if any, additional operational costs.
Box 6.2 Beyond Carrying Cash: Informal Money Transfer Systems
Source: Isern, Deshpande, and Van Doom 2005.
tontines (West Africa), chit funds (India), kibati (Tanzania), stockvel (South Africa), and esusu (Nigeria). ROSCAs are the simplest form of finan-cial intermediation: several people form a group and contribute an agreed amount on a regular basis. At each meeting (or round), the money is collected, and the total is given to one member on a rotating basis. When the last member has received the lump sum, the group can choose to start a new cycle or disband.
Easy to form and manage, ROSCAs are com-mon in many countries. A study by the Institute for Financial Management and Research in India estimates that the registered chit fund industry could be as large as 10–50 percent of all lending to priority sectors; the unregistered chit fund mar-ket could be as large as 15 times the registered market (Linder 2010).
ROSCAs are structured to allow for financial services overseen entirely by group members.
Since all members contribute the same amount at each meeting, each individual member accesses the same sum of money at some point during the life of the ROSCA for use at her discretion.1 Transactions take place only during regularly scheduled meetings (often monthly) and are typ-ically witnessed by every member. In addition, since no money is retained by the group, often no records are required (other than possibly the list of who is to receive the funds when), and there is no need to safeguard funds. The system further reduces risk to members because it is time limited— typically lasting no more than 12 months.
This mitigates potential losses should a member take the funds early and stop contributing. These characteristics make the system transparent, flexible, and simple, providing a financial service well suited to poor communities with low literacy rates. At the same time, many people who are better- off financially also join ROSCAs, both to save for a specific purpose and to take advantage of the social capital that develops. While ROSCAs typically attract more women than men, mixed ROSCAs also exist.
illegal activities is also a risk, even though most people are not aware that they are taking place.
Informal providers require minimal documenta-tion and, by definidocumenta-tion, are not regulated.
Indigenous Groups
Member-owned community groups have proven effective in providing basic financial services, especially in remote areas or urban slums char-acterized by inadequate infrastructure and low savings and debt capacity. They provide mem-bers mutual encouragement to save and to use money wisely, as well as an economic safety net to protect them in the event of sudden hardship.
In so doing, they promote savings discipline, build social capital, increase assets, and decrease household vulnerability to financial and other shocks.
Poor women and men find these groups easily accessible because they are local and offer few barriers to entry. Members know each other and learn to rely on each other to achieve financial goals together that would be unattainable alone.
A common goal of community-based financial groups is accessing a lump sum of money, either through saving or borrowing, where embedded social relations reinforce repayment. Some groups establish social funds to help members in times of crisis. This experience of managing funds together and using their collective strength both to enhance household finances and to help friends in need builds solidarity within groups—
one important reason why people often maintain their membership in community-based groups even after they have gained access to formal financial services.
There are three predominant types of indige-nous groups: ROSCAs, ASCAs, and informal microinsurers.
Rotating Savings and Credit Associations ROSCAs exist in developing countries around the world and are known locally by many names:
merry-go-rounds (Kenya), tandas (Mexico),
save regularly, but the combined contributions are not distributed at each meeting; instead, sav-ings are pooled for the purpose of lending to members. While all members save, not everyone borrows. Members borrow only when needed, in amounts that they and the rest of the members are confident will be repaid.
Since members do not all transact in the same way, ASCAs are more complex than ROSCAs.
Members may borrow different amounts on different dates for different periods. Interest payments provide a return on savings that is shared fairly among the group. ASCAs may be
“time-bound,” with members saving, borrowing, and repaying for a predetermined amount of time, usually 6–12 months. However, given the diversity of indigenous ASCAs, the cycle can vary in length, with some choosing to operate indefinitely (see box 6.3). Depending on the time frame and the simplicity of their structure, ASCAs can operate without keeping any records by periodically dividing the accumulated funds equally. However, more complicated ASCAs require bookkeeping, particularly those that deal in large amounts or operate for long periods of time.
However, a ROSCA’s simplicity is counterbal-anced by risk and lack of flexibility:
• All ROSCA members receive the same amount of money in a predetermined order. Each must wait her turn regardless of need, and there is no flexibility to contribute more or less than the agreed amount.
• The fund does not grow in value, as no loans are made and no interest is paid.
• Those who are last in line risk not receiving their payout if the group disbands. When a ROSCA collapses, members who have not yet received their proceeds have no recourse.
As a result of these limitations, informal sec-ondary markets may be created, whereby one member pays a premium to another member to switch turns. These premiums sometimes exceed 50 percent or more of the value of the proceeds.
Accumulating Savings and Credit Associations While still indigenous, an ASCA is a more flexible and more complex group savings mechanism than a ROSCA. Like a ROSCA, group members
In northern India, the good ASCA leaders
In northern India, the good ASCA leaders