The main advantage of the informal sector -- its lower transaction costs -- results from the specialization in small loans and clients. The lower costs can also be attributed to absence of legal reserve requirements and to the minimal regulation in relation to those in the formal sector. Informal entrepreneurs' lower costs may result from such factors as not paying pay-roll taxes, observing minimum wage regulations, disregard of building standards, sanitary regulations, property taxes, etc.
Credit programmes for the poor have generally been set up on the assumption that the poor cannot pay the real cost of credit and that the poor cannot save. Accordingly, credit schemes have involved subsidized rates of interest and there has been a tendency to create solely credit programmes instead of offering a viable arrangement that would enable the poor to accumulate savings as well. These schemes have also been characterized by an orientation towards social welfare in terms of staff skills and attitude. In other words, the poor have been seen as "beneficiaries" rather than "clients". While there are understandable reasons for this approach, experience shows that it has not been particularly effective as recovery rates have been generally low, and mobilization of savings have also been low. This approach delayed the development of a commercial or a cost-effective method of credit delivery and has led to a rapid depletion of the value of loan funds. A more commercial approach to the provision of credit and mobilization of savings would tend to provide financial services that meet the needs of the poor, have good recovery, mobilize savings and become sustainable. Examples of successful projects such as the Grameen Bank (Bangladesh), the Bank Rakyat (Indonesia) and Predom (Bolivia) all illustrate that the quasi-formal commercial approach can be effective. Experience shows that although subsidy exists, as in the case of Grameen, borrowers could pay a rate that would make the bank profitable. The recorded recovery rate of loans is one which regular banks in Bangladesh, where the average rate of default is particularly high, have never approached. Moreover, evidence indicates that substantial savings can be generated by the poor, including, [inter-alia], through "forced" savings, such as deductions on loans, as in the case of the Grameen and Predom Banks. These small loans have proved to be very effective in reaching the poor.
The Grameen Bank was set up by a Bangladeshi economics professor in order to lend money to the poorest of the poor -- enough for some hens, or the cow or rickshaw which can make them independent. The initiative was taken because conventional banks had been ignoring the needs of Bangladesh's 80% poor and illiterate, because they were said to be "bad risks". The bank operates on foot or on motor scooters around the villagers. It has been enormously successful, with payback rates of 98% (compared with 90% for Western banks lending to well-off middle classes). It has been copies all over the third world, and now in Western cities like Chicago and Birmingham.
The mission of the Foundation for International Community Assistance (FINCA) is to support the economic and human transformation of families trapped in poverty through the creation of Village Banking groups. These are peer groups of 30 to 50 members-predominately women- who receive three critical services: (1) working capital loans to finance self-employment activities, (2) an effective mechanism for promoting family savings; and (3) a community-based system which provides mutual support and encourages self-worth. FINCA launched the first Village Banking programme in 1984.