Why isn't there More Financial Intermediation in Developing countries?
This paper presents the opportunities for improving and extending financial markets and safety nets for the poor, by focusing on factors that may explain why the linkage of local financial networks and safety nets with the larger economy often fails or is incomplete. It outlines:
- Types of intermediaries, kinds of costs and benefits they expect from transactions, and;
- Evidence regarding the relative absence of these institutions in many economies.
The paper also:
- Offers a simple insurance model summarising how information asymmetries and costly enforcement constrain contracting in agency relationships where side-contracting is possible;
- Summarises recent theories of lock-in and models that incorporate more of the social and political realities of village and slum life, and;
- Discusses policy and innovation.
The paper argues that understanding the nature of these impediments is the first step in proposing policies to help promote more effective linkage and intermediation. It proposes four explanations for the lack and slowness of adoption of intermediation:
- High costs of delegated monitoring aggravated by limited intermediary capital;
- Lock-in and crowding out effects from local insurance arrangements, social norms against cooperation with intermediaries;
- Political resistance to new institutions that shift the balance of power in local polities, and;
- Financial repression and weak legal systems.
The paper concludes that the kinds of supply-side innovations and issues discussed are only relevant once the basic groundwork of enforceability has been laid, through the maintenance of legitimate legal institutions. It suggests ways of reviewing public policy for more effective intermediation, especially as it affects sub-Saharan Africa.
