Informal Finance in Developing Economies

Abstract

The financial systems and financial markets of developing countries have a common feature: the dualism. This means the co-existence and operation side by side of a formal or institutional financial sector and of an informal or non-institutional financial sector. The great diversity of informal financial activities makes difficult to evaluate the actual extent of informal finance in each economy, but empirical evidence in a number of less developed countries suggests that such extent is always relevant. Many examples bear witness of vitality of informal finance in filling the gaps left by operations of formal financial intermediaries: segments of the market neglected, credit rationing pursued through non-price allocation, exorbitant transaction costs shifted off to borrowers. The paper provides a comprehensive study of the role of informal finance in these economies, in rural as well as in urban areas, and of the main characters of the informal financial markets. Credit markets where heterogeneity of lenders faces heterogeneity of borrowers: different lenders may have different information about different borrowers. It investigates financial markets of developing countries highlighting crucial topics such as innovation capacity, effectiveness in personal savings mobilization, competition in funds rising and in credit supplying, personalistic relationship, interest rates charged, transaction costs inherent to financial intermediation, asymmetrical information, moral hazard, credit risk (arrears, delinquency, default), market interlinkage. Various types of operators of the informal financial sector, both individuals (moneylenders, pawnbrokers, indigenous bankers, traders, deposits collectors) and mutual associations (Roscas and Ascras), are listed and analised. Finally due attention is given to interlinks between formal and informal financial circuits: large financial flows can take place, in fact, between formal and informal sectors. Furthermore a pronounced complementarity of the two sectors emerges: in many instances informal finance should not be seen as a substitute of institutional finance, as it has been often done in the past, but rather as a complement.