14 reasons why the Informal Credit Markets (ICM) are used by the Poor

Hari Srinivas Based on research of informal credit operations in urban areas of India, Thailand and Philippines, fourteen reasons were identified that lent support to some of the positive aspects of the informal credit markets. The ICM, as identified here, covers money lenders, pawn brokers, community credit groups, NGOs, 'credit societies' people's organizations etc. The material is based on Srinivas, Hari, "Viability of Urban Informal Credit to Finance Low Income-Housing: A Case Study of Three Squatter Settlements in Bangalore, India". Unpublished Masters Thesis. Division of Human Settlements Development, Asian Institute of Technology, Bangkok, Thailand, 1991.

It does not require a license.

In order to set-up an informal credit operation, it is not necessary to have a license (except in the case of money lenders and pawn brokers). This ensures that procrastinated procedures and paperwork in setting up credit operations is avoided, encouraging wider participation and ease of entry. However, simple steps like registration of a people's organization as a "society" or association under the law will provide legal validity for such groups (Note: money lenders and pawn brokers have to comply with the Money Lenders Act and Pawn Brokers Act respectively - but compliance and enforcement is rare). Low incomes also mean that the amount saved is very small, since most of the income is used for consumption purposes. The small amounts saved is not attractive to banks, but find ready acceptance in the informal credit groups. A typical example was a women's group, Mahila Mandal, in a squatter settlement. One of the women, appointed as a "treasurer" normally sat in her front yard doing her household chores. Women who returned from their daily shopping simply passed on all the small change they had with them to the treasurer, who made a notation of the amount in a ledger she kept with her. The money saved was small - about Rs. 1 to 5 (3 - 16 US cents) daily, but on a sustained cumulative basis, amounted to significant figures and was used to give very low interest loans to the group's members.

It facilitates very small savings behaviour.

It is non-profit motivated.

Most of the credit activity are based on the principles of solidarity and mutuality of actions. They are not motivated by profit. Democratic decision-making processes within the group ensures that benefits, if any, of the credit transactions are evenly distributed to all its members. Credit activities by groups are, in many cases, part of the overall activities of an organization, for example, a women's group or a youth club and hence involves a democratic setup. These groups have a president, a secretary, a treasurer and members. With the assistance of a social worker or an NGO, they also draw up "constitutions" and have the group registered as a voluntary society. Regular meetings of group members ensure that all of them take part actively in its deliberations and benefit from it. Dynamic leadership also plays a part in these organizations. The women's group mentioned above used their savings as a deposit in a bank to get loans to buy sewing machines for its members, and also mobilized a local company to donate more machines for training purposes. Most transactions took place with close proximate links, both physical and psychological. This allowed them to assess the earning capacity and relative risk of the borrower, observe closely his/her expenditure patterns, and also ensure repayments. This obviated the need for collateral or guarantees since transactions took place on a face-to-face basis. Terms and conditions of loans were kept flexible to take care of an eventuality (Collateral is, however, an intrinsic part of pawn brokers' operations. For example, household goods, gold and jewelry etc. are used as collateral). Contrary to popular belief, the number of operators in the ICM are many and competition among them keen. ICM suppliers overcame this by supplying on a highly localized basis - only within the same settlement, or in the same ward. For example, in a study of informal suppliers, 64.4 percent of the money lenders operated in the immediate vicinity of the settlement, 85.7 percent of pawn brokers operated only in the city ward. The advantage of localized services is that they would be able to tailor their loans to the specific needs of borrowers in the area, and at the same time keep close links with them.

It has strong organizational structures.

It does not need collateral.

It provides localized services.

It has specific borrowers identified.

Most credit-based groups like ROSCAs and people's organization serve specific and definite groups of borrowers. They are organized on the basis of location, ethnicity or place of work. Locational criteria include same lane, street, cluster or settlement and ethnicity criteria are, same religion, language or place of origin. Banks and other formal institutions, who maintain an impersonal relationship with their borrowers, operate on structured and universal operating procedures which are common to all borrowers. But most informal suppliers operate on a highly personal basis, depending on the needs and wants of its members. Procedures could also be modified during a credit cycle. For example, ROSCAs decide on the winner of the collected "pot" by two methods, lottery or bidding. This decision of choosing the method is decided by the members themselves. The organizational structure of settlement-based credit groups are ordered and systematic, since a group is involved to which the activities of the organizers are liable and answerable. Proprietorship of the credit activity rests with the group as a whole. Informal credit suppliers do not usually demand collateral against loans taken by borrowers. Therefore, in order to minimize risk of default, most suppliers maintain close informational links with their borrowers. They lend only to people they know well, or are well recommended by a prominent person. For example, one money lender lent only to borrowers who had transacted earlier with his father, or with the sons of those borrowers. Due to strong organizational structures, personalized services, close informational links, specific borrowers etc. the repayment rates are also high. Participation in a group generates peer pressure from other members that would ensure repayment. Besides, certain groups also have a rule that only after a previous loan was repaid, would the borrower be eligible for a fresh loan. Keeping the loan terms and conditions flexible also help in high repayment. Many money Lenders, ROSCAs, People's Organizations and pawn brokers allow the borrowers to extend repayment periods from originally decided periods by one to four weeks.

It has personalized services.

It has multiple proprietorships.

It has close informational links.

It has high repayment rates.

It facilitates reciprocation of credit disbursal. It is not regulated by the central bank. It encourages community participation in other fields of development.

Community based credit activity particularly encourages reciprocation of credit disbursal. It encourages people in a give-and-take situation to borrow and lend. Consistent savings behaviour and good repayment records also increases their overall credit worthiness, making them attractive to commercial banks. Regulations normally imposed on financial institutions, such as auditing requirements, priority lending, and other rules regarding loan application processing do not apply to informal suppliers. This imparts considerable flexibility in the operations of informal suppliers, and helps them to respond efficiently to the needs of the market. Credit is a common objective that can be used by the community as a rallying point and use such participatory activity for other settlement development activity. Experiences gained by group activity, leadership training etc. and the generated finance, can be used for other activity in the settlement, like education, health, infrastructure etc.