A Continuum of the
Informality of Credit

Hari Srinivas
Policy Analysis Series E-060. June 2015.



he commonly held belief of credit market "duality" in the form of "formal" and "informal" is misleading and any attempts at aggregation have either a locational or sectoral bias (core/periphery, urban/rural, modern/traditional).

The varying degrees of informality and flexibility observed in informal credit markets (ICMs) are complex and multi-dimensional, with characteristics ranging from freedom from regulation, flexibility in interest rates and periods, to small scales of operation etc.- covering both its organizational and operational features.

The field study that provided background data for this document was carried out in the city of Bangalore, India, and covered more that 200 households in five urban squatter settlements, and over 50 informal credit suppliers, who operated in those settlements.

In an attempt tp characterize the complexity and variety in ICMs, a continuum of informality of credit was developed to explain the interconnectedness. Such a continuum help show the gray overlapping areas in ICMs - those informal operators who exhibit characteristics of formal suppliers or formal suppliers who have adopted the working systems of the informal supplier.

The continuum was not plotted in the typical linear manner, but on a dual-axis format. This was done by distinguishing loan conditions into "monetary" and "non-monetary" components along the x and y axis.

  • Monetary components covered loan amounts, rates of interest, loan periods and repayment schedules;
  • Non-monetary components covered transaction amounts, collateral requirements, proximity to borrowers and personalized services

In charting the continuum, focus was maintained on suppliers who provide informal credit in urban squatter settlements. Unlike formal credit institutions, most functioned as single entities with few linkages between operators. But the number of operators in the market were many, contrary to popular belief, with competition keen among them.

The Continuum

Click on the image above for a larger version of the image.

The Continuum's Quadrants

The essential constituents in the continuum were:

  1. Informal Suppliers - those who exhibit fully informal characteristics in their setup. Examples include friends, relatives and neighbours.
  2. Formal Suppliers - those who exhibit fully formal characteristics, examples include, commercial banks, finance corporations/ companies.
  3. "Informally-formal" suppliers or Transactional Credit Suppliers - those who are essentially 'formal' in their setup, but exhibit 'informal' characteristics. Examples include pawn brokers, money lenders and employer credit.
  4. "Formally-informal" suppliers or Mutual Credit Suppliers - those who are essentially 'informal' in their setup, but exhibit formal characteristics. Examples include Chit funds (ROSCAs), credit societies and people's organizations.

Numbers three and four above represent an attempt to make distinctions within the "gray areas" of ICM characterization. A number of unique features of the market are cast in perspective with such distinctions.

The data to construct the continuum was obtained from a survey of 256 households in six squatter settlements of Bangalore, India. While this covered the demand side of the market, 56 informal credit suppliers were also studied to cover supply side of the market. The study was conducted in June-July, 1991.

Transactional Credit Suppliers


ransactional credit suppliers are those for whom credit is a "transaction". Examples include pawn brokers, money lenders and employer credit. Most of these suppliers use their own funds for providing credit. Some of the characteristics (presented in contrast to the other two categories) which are common to suppliers under this category are:

Immidiate availability of credit:
If the borrower establishes credit worthiness, the credit/loan is usually made available by the supplier immidiately, typically within a few days.

Suppliers own funds:
The source of money for informal credit loans are usually the supplier's own funds or profits made from previous transactions. A certain amount of borrowing from other suppliers also takes place. Borrowing from commercial banks is rare.

No encouragement to save:
Transactional suppliers make no obligation on the part of the borrower to save a particular amount, that is, loans are not linked to the savings behaviour of borrowers.

Reduced proximity to the borrower:
The proximity of the transactional suppliers to the borrower's residence is less compared to other supplier groups (some money lenders, for example operate from the same settlement).

Less flexible terms and conditions:
Terms and conditions of credit are less flexible and more strictly enforced compared to other suppliers. Default by the borrower on the other hand is also rare (though not necessarily due to strict enforcement).

Compliance with the law:
Pawn brokers have to comply, by law, to "The Karnataka Pawn Brokers Act of 1962" and Money Lenders to "The Karnataka Money Lenders Act of 1962". These acts set the rules and regulations for operation and issues permits for weration. However enforcement by the authorities is loose and compliance by the suppliers is rare.

Small organization size:
Transactional suppliers are either single suppliers, or belong to the same family, a group or company.

Regular, cyclical operations:
Operations of the suppliers are regular (on a daily basis), that is, it is cyclical in nature and fairly organized.

Borrower evaluation:
Asset holding, social standing, economic viability are some of the important criteria for evaluating borrowers.

Thus, to summarize, one of the central ideas which distinguish the transactional credit suppliers is their timely credit: Credit should be made available at that time when it is most needed and with the shortest possible transaction process and time.

Mutual Credit Suppliers


hit funds, credit societies and people's organizations have been grouped under this category because credit supply is mutual - that is, a give-and-take situation exists here. While for one period a participant may be a lender, during another period, he may be a borrower. Therefore participants are typically support each other for credit needs in a mutual faction. Some of the main characteristics found in mutual suppliers are:

Savings-linked credit:
Credit supplied by this group is typically savings linked. Only if the capacity to save has been demonstrated and a specified amount saved, is a loan given to the participant.

Interchangability of participants:
Members are typically suppliers at one point of the process and demanders at another. The money "supplied" or saved by some participants is "lent" or borrowed by some other participants.

Equal benefits:
The benefits of the operation are mutual to all participants and equally distributed. Profit or greed is not a motivating factor here.

Regular operations:
Operations of mutual suppliers are fairly regular and organized, though transactions may be more widely spaced in time compared to other suppliers.

Internal funds:
Funds for lending or borrowing are typically generated from within the participants of the organization (though some organization may use the funds generated internally as security for formal bank loans).

Borrower evaluation:
Trust and social/cultural and religious links are very important criteria for evaluation.

Enforcement of terms and conditions:
Terms and conditions are typically enforced in a strict manner and default is very rare, especially since borrowers are properly screened before their participation is accepted.

Flexible operational characteristics:
Operational characteristics are usually kept flexible to suit participants needs and wishes, especially since these are decided by the participants themselves. For example, the mode of selection of the "pot" in a chit fund may be by lottery, bidding or other means, and this mode is previously decided by the participants.

Availability of credit:
Housing finance is typically an immediate necessity and credit from mutual suppliers may not be available at the time of need since the borrower has to wait for his chance. But borrower usually overcomes these shortcomings by obtaining a loan from a money lender using the money saved in the chit fund as a security.

To summarize, the central idea of mutual credit suppliers is that they encourage savings from the participants. A savings-linked loan system is more advantageous to all parties concerned and makes full use of all financial resources available to the maximum extent, besides reducing the dependence on external sources of finance.

Personal/Casual Credit Suppliers


ersonal credit suppliers are usually single individuals who supply credit on a "casual" and unencumbered manner. Typically, casual suppliers include friends, relatives, neighbours etc. Some of the characteristics common to all the casual suppliers are:

Single operators:
Casual operators are typically single individuals who operate in a need-based manner.

Irregular supply:
The credit supplied by the casual suppliers are irregular, not always available. That is, only when surplus funds are available with the individual or only when requested by a close friend/relative/neighbour, is the loan made.

Very few terms and conditions:
The terms and conditions imposed on borrowers from casual suppliers are very few, usually with no interest payments or regular repayment schedules. Transaction records are not usually kept.

Credit given by casual suppliers is usually loosely transacted and is considered as a "favour" made for a future reciprocation by the borrower.

Very close proximity:
The physical proximity of the borrower and the lender is usually very close, either in the place of work or in the settlement itself.

Here is a central idea from casual suppiers: the very flexible terms and conditions and reciprocity of the transaction which does not place any undue obligation on the lender or borrower.

Formal Credit Suppliers


oncentrating as we are on informal credit markets, the position of formal institutions has only been shown in the continuum to complete the picture of credit markets as a whole. Such institutions would range from Commercial Banks, Development Finance Institutions and Regional/Rural Banks to specialized financial institutions such as Housing Finance Banks etc.

These are well researched in the literature and hence do not form part of the explanations and links in this Continuum.


Abstracted from:
Srinivas, Hari and Yoichiro Higuchi, "A Continuum of Informality of Credit: What can Informal Lenders Teach Us?" Savings and Development Vol. XX, No. 2, 1996.

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Hari Srinivas - hsrinivas@gdrc.org
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