Rural Finance and Poverty Alleviation

Does the formal sector have lessons to learn from the informal sector?

This report presents in formation on the credit constraints that poor rural households face, derived from detailed rural household surveys conducted by IFPRI and its collaborators in nine countries of Asia and Africa (Bangladesh, Cameroon, China, Egypt,Ghana, Madagascar, Malawi, Nepal, and Pakistan). The report:

  • Makes the case for appropriate public intervention in strengthening rural financial markets and draws conclusions about areas where public resources may best be spent;
  • Describes how informal, often indigenous institutional arrange ments have succeeded in tailoring savings, credit, and insurance services to the poor.

The paper also asks:

  • What enables informal institutions to provide sustainable financial services that banks and cooperatives in the formal sector institutions fail to provide?
  • What are their strengths and weaknesses?
  • What lessons can formal sector institutions draw from them?

The report argues that:

  • The basic problem lies in institutional arrangements, transplanted from urban-based formal banking systems with high transaction costs for lenders and borrowers alike;
  • For the lender, these costs are incurred in screening large numbers of borrowers, monitoring and enforcing unsecured loan contracts, and managing tiny savings deposits;
  • For the borrower, these costs take the form of time and other resources spent securing loans or making deposits, or inappropriate deposit or loan terms.

Finally, the report looks at examples of recent institutional innovations that overcome some of these obstacles. It concludes that:

  • Just as there is a role for the public sector to develop or support science- based technologies, concerted public action is also needed to create an enabling environment in which institutional innovation is encouraged and given more room to spread;
  • Governments, donors, banking practitioners, NGOs and research institutions must work together closely to pinpoint the costs, benefits, and future potential of emerging rural financial institutions.