Increasing effectiveness of informal lending
Context: In many developing countries, poor rural households face severe constraints when they seek credit from formal lending institutions. Formal financial services such as those offered by banks are often not available to those below the poverty line because of restrictions requirng that loans be backed by collateral. Nor do banks welcome the small amounts the poor want to save. As a result, the poor usually turn first to informal sources such as friends, relatives or moneylenders, who loan small amounts for short periods, or to informal, indigenous insitutions such as saving clubs and lending networks to borrow enough to purchase food and other basic necessities. These informal networks are frequently successful in tiding the poor over difficult times, such as a bad harvest, and they enable poor households to build up saving for investments that can help lift them out of poverty.
Implementation: A study by the International Food Policy Research Institute finds the following factors important in the effectiveness of informal lending: (1) A credible long-term relationship is the key to enforcing loan repayment: the borrower will repay the loan if he or she expects to be able to borrow again in the future. (2) Financial services should be tailored to the demand patterns of the borrowers. For example, farm loans that can only be used for seeds or fertilizer reduce the flexibility of the household to make the best use of the loan. (3) Decisionmaking on loans granted should be made at the local level. (4) Institutions ought to have clear plans for loan recovery before lending begins. (5) Group-based transactions hold promise, but more research is needed to compare group lending and saving activities with other member-based insitutions such as credit unions and village banks. (6) Saving services should be provided. (7) Incentives for managers of rural financial programmes should be built into the programmes.
Type Classification: D: Detailed strategies