Dimitri Vittas
Published: 1999
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November 1995 The history of development of U.S. and European thrift deposit institutions (banking for the poor) yields lessons for today's developing countries. The financial systems in most developing countries today have many features in common with the financial systems of the developing countries of the eighteenth and nineteenth centuries. Whether they had unlimited liability (as in Scotland in the eighteenth century), or limited liability and special charters, commercial banks dominated European and U.S. financial systems. Moreover, they were typically established by wealthy people and oriented toward businesses and other wealthy people -- they effectively represented banking for the rich by the rich. Insurance companies were underdeveloped and pension and mutual funds did not yet exist. As a result, middle- and low-income people had limited access to formal financial services and relied on informal arrangements for borrowing. Meanwhile, financial savings were unproductively hoarded under the mattress. In developing countries today this gap in the provision of financial services can be explained by the low level and unequal distribution of income and wealth, high information and transaction costs, and weak enforcement mechanisms. In Europe and the United States, over time, different types of institutions -- including savings banks, credit cooperatives, building societies, and credit unions -- emerged to fill this market gap. Many developing countries have created institutions that specialize in lending to the poor, but more must be done to help these institutions reach the poor in rural areas and assist small farmers, artisans, and traders. An integrated program to build solid institutions requires five elements for success: * Strong leadership. (Support should be given to groups, such as the Church or local officials, likely to attract people with integrity, high ideals, and commitment to the institution's success.) * A three-tier structure. * Strong emphasis on education and the dissemination of information about the workings and benefits of the institution. (Culture can be an obstacle to a thrift institution's success, as the Irish experience shows.) * An official policy that encourages self-help and avoids total reliance on external funding. External support could be made dependent on local resource mobilization and a record of monitoring and repayment. * Most important, the encouragement of active peer monitoring and the enforcement of contractual obligations. The principle of unlimited liability may not be viable in most developing countries, but government could support only regional units and local institutions that have a good record of loan repayment. This paper -- a joint product of the Finance and Private Sector Development Division, Policy Research Department, and Financial Sector Development Department -- was presented at a Bank seminar, Financial History: Lessons of the Past for Reformers of the Present, and is a chapter in a forthcoming volume, Reforming Finance: Some Lessons from History, edited by Gerard Caprio, Jr. and Dimitri Vittas.