Informal Finance?
The many positive aspects of informal finance in providing services for the poor could become lessons to be learned by micro finance providers in order to improve their performance and services for their poor clients. The advantages of informal finance that can be copied by formal financial providers, according to lohnson and Rogaly ( 1 997: 24-25) include, firstly, its range of financial services such as saving facilities, credit for consumption, and funding for predictable but expensive events such as marriages and funerals; secondly, its lower transaction costs than the formal lenders, since the informal lenders are usually localised, who do not need travel costs and are sometimes without administrative procedure; thirdly, informal finance imposes discipline on the borrowers. The local flow of information among relatives and friends and the small number of lenders or credit schemes result in social pressure for the borrowers to repay on time.
Ghate ( 1 992: 1 63) focuses on the flexibility feature of informal finance that makes the schemes match with the need and capacity of the poor. Interest rate flexibility has allowed informal finance providers to cover a large range of clients. In addition, the flexibility of the repayment schedule contributes to the higher repayment rates and therefore reduces risks premium, as well as allowing less chance for foreclosure of an
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account. Also, the greater flexibility regarding the duration of loans and charging of interest only for the duration of a loan is more convenient for small and medium borrowers. It is argued that daily repayment loans are not only convenient for the borrowers, but also they greatly reduce risks, and keep the lenders supplied with up-to date information about the borrowers (Lava et al 1 988 cited in Ghate, 1 992 : 1 63).
However there are also many negative aspects of informal finance that the micro finance providers should avoid. Germidis et al. ( 1 99 1 : 49) argue that the high interest rates charged by informal lenders such as merchants, middlemen and landlords are socially unacceptable, especially among poor borrowers in rural areas, where the borrowers often may not realise the true rate of interest they are paying and either do not know, or do not have access to, an alternative source of finance. It is also reflected that the high interest rates indicate high costs of financial intermediation in informal finance. Another criticism is that since informal loans are mostly used for consumption purposes, it is often argued that the flow of funds are more from savers to consumers rather than into productive investment for development, and therefore informal loans discourage economic development. Also, since the informal finance is usually positioned outside the control of public authorities, its existence and expansion could cause ineffective financial and monetary policies in developing countries.
Conclusion
In this chapter the concept of informal finance has been discussed. The concept of informal finance, has now become an important tool for the savings and credit activities of the lower income people in developing countries. There is a wide range of credit and savings facilities in infonnal finance from intermittent lenders to friends and relatives, professional lenders and tied lenders, to group or mutual finance. The widespread nature of ROSCA and other group finances in most developing countries supports the accumulation of capital, and therefore strengthens economic development of the respective communities.
The important mechanisms of informal finance at the local level are sometimes overlooked by researchers or practitioners, especially regarding its interactions with local cultures and values and its role in enhancing social capital and decentralisation. In
7 1 fact, the influence of local culture and values upon social and economic organisation is important in the collectivist society of developing countries. People tend to be grouped based on their ethnicity, religion, and familial group. The setting of interest for example, which is one aspect in informal finance, is highly criticised by Islamic society. The rationale for banning interest in the banking system has resulted in the increasing popularity of the concept of Islamic banking, which is now widely used by banking companies in both Islamic and non-Islamic countries. Similarly, the close interaction between members in informal finance, especially in group or mutual finance, has resulted in tight relationship among the members, which in turn strengthens the community's social capital. In the same way, the bottom-up approach of the establishment of informal finance is supportive of the successful implementation of decentralisation.
Despite the above positive features, there is still a largely negative view towards informal finance especially regarding moneylenders. Poor people usually use moneylenders as the last resort, when other options of credit sources are unavailable. It is often suggested that moneylenders take advantage of uneducated people and lack of knowledge of credit.
The positive and negative features of informal finance as mentioned above are important for the development of local financial systems in developing countries. These could become lessons to be learnt by researchers and policymakers to design future rural financial systems.
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