Do Financial Institutions Have a Role in Assisting the Poor?

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1994-09

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Ohio State University. Department of Agricultural, Environmental, and Development Economics

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This paper discusses the role of financial services in the reduction of poverty. It first examines changing views about poverty and the design of poverty alleviation programs, both in the United States and the developing countries. It claims that financial services can play a role in incorporating the poor in processes of economic growth, but not in mitigating the plight of those with no productive opportunities. The paper briefly reviews the functions of finance in the economy and argues that there is a public interest in promoting the efficient provision of financial services. One potential cost of poorly designed programs is thus a reduced efficiency of the financial system. Moreover, credit programs that in the past pursued non-financial objectives have been generalized failures. Thus, financial services can assist the poor only when they do what finance is supposed to do: facilitate payments and liquidity management, intermediate, and deal with risk. Moreover, deposit facilities are usually more important for the poor than loans. In turn, the demand for credit is not just a demand for loanable funds; it is a demand for a client relationship that offers a credit reserve. Since this requires a sense of permanency, institutional viability is required. Lack of viability was the greatest shortcoming of the subsidized, targeted credit programs of the past. Informal finance is reliable, but limited in scope. Viable formal intermediaries must be developed, but this is a costly exercise. A hospitable policy environment, appropriate technologies, and incentive compatible organizational designs are required.

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