Informal Markets: What Lessons Can We Learn From Them?

This policy brief attempts to derive lessons from various informal financial service providers, which have been successful in reaching the poor with financial services. It attempts to identify reasons why they have succeeded, where formal financial service providers have not. It highlights the relevance of these lessons for public policy.The brief examines three types of informal financial institutions, namely relatives, neighbors and friends, rotating credit and saving associations, and tied credit transactions. Lessons from these informal systems include:

• Belief that the benefits of long-term partnerships are greater than short-term gains propels self-enforceability of informal institutions;
• Informal institutions tailor their financial services to the specific conditions of poor households;
• Intimate knowledge of the local economy and local institutional arrangements can be used to strengthen financial links between the borrower and the lender;
• Decision-making needs to be decentralized, with front-line managers being actively involved in designing financial products;
• Not all financial contracts are self-enforcing and adequate steps must be taken to enforce contract compliance.