The Efficiency of Informal Finance
- Are the services provided by informal lenders "valuable" for their clientele?
The answer is a strong "yes" and for this reason I have always opposed the repression of informal financial arrangements. They should not be viewed as "evil" but rather as providers of valuable services actually demanded by their clientele. Without those informal arrangements, many times these services would not be provided at all. It would not be difficult to show that these informal services are welfare-improving for those who use them.
- Are the services provided by informal lenders "sufficient," from the perspective of their clientele?
Under many circumstances, the answer in this case is possibly "no." Informal lenders typically do not provide a sufficiently wide collection of the services for which a demand exists (e.g., deposit facilities, money transfers, certain types of loans). There are exceptions, of course. Several of these "missing" services, however, are demanded by the poor and if they were available they would also be welfare-improving.
Moreover, informal financial services are either a part of a larger network of relationships (friends and relatives), which carry particular (but difficult to measure) costs, or are (clearly with justification, but still) quite costly. It is not surprising, therefore, to observe a demand for those semiformal and formal financial services that are cheaper and that are at the same time permanent and reliable. Increasing access to less costly services will also be welfare-improving.
- Are informal financial services "efficient" from an economic perspective?
The answer here is a strong "no." There are several reasons for this. Informal financial arrangements are competitive mostly within small market segments, for financial transactions among agents who are in close "proximity." Beyond the local boundaries, informal finance is "prohibitively expensive" (and for this reason, one hardly ever observes these types of finance among agents who are "far away" from each other). The information costs for screening and monitoring borrowers are too high.
In consequence, informal finance cannot contribute to the reallocation of purchasing power throughout the economy, critical for increases in the productivity of available resources. In this sense, informal finance is not socially "efficient" and cannot contribute to economic growth as much as formal finance (wider in scope) could contribute if it is made available. Informal finance leaves too many opportunities to improve resource allocations untouched.
- Can informal financial transactions be replaced and/or complemented with formal financial intermediation?
The answer is "potentially yes," but the task is not easy at all. The development of financial systems in many countries is an illustration of how this process takes place. Since the provision of formal financial services is very costly, the process takes a long time and requires major improvements in infrastructure and institutions.
To reach the poor one would require, in addition, innovations in financial technology. Are these innovations possible? There are a few examples that suggest that this is the case, under certain circumstances (which may not be present in every country). On the other hand, informal finance will never disappear, but it will occupy an increasingly less important niche as formal finance is developed.
Valuable financial services are provided by informal arrangements. Economic development will require, however, the provision of additional (also valuable) formal financial services (to replace or complement the former). While understanding and appreciating the role of informal finance, the real challenge is to discover the appropriate combinations of technologies, organizations, and policies needed to develop formal financial systems at the national level.
Claudio Gonzalez-Vega in the DEVFINANCE list.
Clgonzal@postbox.acs.ohio-state.edu
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Hari Srinivas - hsrinivas@gdrc.org
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