Financial systems and development

original amount to the renter by the end of the government programs of directed, low-cost lendrental
period. ing have experienced serious difficulties. Two
types of lending arrangements, which fall in the
Limitations of informal financial arrangements
gray area between informal and formal finance, offer
some promise. These are group lending
Despite their success in providing financial ser- schemes and cooperative financial institutions,
vices to small businesses that would otherwise lack which can be found the world over.
them, informal financial arrangements do not meet
all the needs of the sector. For example, such ar- Group lending schemes
rangements do not allow savings to be collected
from more than a small group of individuals well The funds for group lending schemes can come
known to one another, and they do not move from a commercial bank, a government developfunds
over large distances. Especially in rural areas ment bank, or private institutions. The role of the
local markets may be segmented from national group varies. In some cases the funds are lent to
markets, which limits the supply of credit. Most the group as a whole, which then allocates them
loans are from family and friends or group associa- among members. Or loans may be made directly to
tions and are at low interest rates. The higher rates individual members of the group. In either case
that moneylenders and pawnbrokers charge are in the group provides a guarantee; it is answerable to
large part due to the higher costs and risks associ- the outside lender for the repayment of loans.
ated with informal loans. But some loans from The idea is that by joining together, small bormoneylenders
are at very high interest rates be- rowers can reduce the costs of borrowing and imcause
of the power imbalance that exists between prove their access to credit. The outside lender's
borrower and lender. In fact, much of the tradi- costs are reduced because lending to a group
tional criticism of moneylenders has derived from lowers the risk of dealing with small businesses
the high interest charges and intimidating prac- and circumvents the problems involved in selecttices
of loan sharks-lenders who often finance ille- ing borrowers. The groups themselves must be segal
activities. Except in housing finance, informal lective in accepting new members. In this way,
arrangements generally do not provide term fi- groups act as a substitute for information about
nance. These shortcomings may inhibit the long- borrowers and thereby reduce the costs of processterm
planning and investment that are necessary if ing loans. Group members encourage each other
productivity is to rise.
to repay on time so that the rest can qualify for
The limitations of informal financial arrange- loans in the future. This directly reduces the
ments do not call for completely new institutions. lender's commercial risks.
Indeed, formal intermediaries have often failed The two most common means of providing
where informal arrangements have prospered. group accountability are (a) joint and several liabil-
Formal institutions, and the policymakers who set ity and (b) limited liability. Joint and several liatheir
rules, might learn much about these markets bility encourages extremely careful selection of
by studying informal arrangements more closely. members because any member can be held liable
Their essential features are these. Transactions are for the defaults of others. It may, however, deter
undertaken by mutual consent, so the arrange- the comparatively wealthy from joining the group,
ments must meet the needs of both the buyer and since they have more to lose. In rural Zimbabwe,
the seller of the service. Transaction costs are kept schemes based on joint and several liability
to a minimum. And lenders are able to reduce the worked well in times of average production but
risk of default by using knowledge that they have fared worse than other schemes in the same area in
already gathered from other social or business times of drought and low production. The threat of
dealings. Sometimes informal arrangements pro- default led farmers to withhold repayment and
vide a basis for establishing links with formal insti- hope for a general amnesty, since they would be,
tutions so as to provide a fuller range of services. in any event, accountable for other members'
debts.
Semiformal finance
Group lending schemes based on limited liability
are more common. In Malawi and Nepal borrow-
Several approaches have been tried to overcome ers are required to put part of their loans in a fund
the limitations of informal finance for the noncor- that would be forfeited if any member defaulted. If
porate sector. As discussed in Chapter 4, many all members repay their loans, these deposits are
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