Financial sector development - Sida

protectionistic policy with respect to capital inflows. All the countries in Sub-Saharan
Africa have had complicated foreign exchange restrictions, including complex rules for
investment and ownership -- both direct and portfolio invevestment -- by foreigners.
Although there is a tendency towards more liberal systems, several of the countries in the
region still retain restrictive policies on cross border capital movements.
7.4 The informal finance sector in developing countries
7.4.1 The informal sector and rural credits
The informal finance sector is generally defined as that segment of the financial sector
which is not controlled by financial legislation and central bank supervision. A sub-division
of the informal sector alienating non-traditional actors (government projects, NGOs, etc.)
to what is called the semi-formal sector is often made. This limits the informal sector to
traditional or indigenous actors and institutions.
Although there are few quantitative analyses of the relative significance of the formal and
the informal financial markets in developing countries, it is a general view that the
informal market dominates over the formal market, particularly in rural areas, and
particularly in Africa. Poorer sections of the populations, notably women, are almost
exclusively dependent upon the informal market.
Financial markets in most developing countries are dualistic in nature with one formal and
one informal segment. The linkages between the market segments are weak and the
market is fragmented. Typical is also that even the informal segment is highly fragmented
with a large number of actors on highly localised markets. Recent theoretical work and
empirical evidence explain this fragmentation with structural characteristics of the market
resulting in asymmetric information and differences in transaction costs thereby refuting
the financial repression hypothesis.
Traditional actors in the informal financial sector include relatives and friends,
professional money-lenders, landlords, traders and shop-keepers and credit and savings
groups (notably ROSCAs).
A key characteristic of the informal financial markets is that they are demand driven
as regards the needs and preferences of their clients. This implies that credits are often
given on the following basis: no collateral requirements, no restriction on the use of
credit, low transaction costs, flexible credit terms, quick processing of requests and no
minimum credit amounts. Formal financial institutions on the other hand are generally
characterised by the opposite on all this points.
The financial services provided on the informal markets are limited with emphasis on
short-term credit. To what extent this reflects the structure of demand or a supply
constraint is not very well known. The limited data available seems to suggest that
savings and borrowing primarily is for short-term income smoothing and consumption
rather than investment. While lending funds are largely mobilised on the informal
markets, there is evidence that deposit services are inadequate.
The conventional wisdom is that interest rates on the informal markets are excessive.
This seems however not fully substantiated. While the fragmentation of the market may
well result in extraction of monopoly profits, a simple comparison of interest rates on
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