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Amount: ₦5,000.00 |

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1-5 chapters |



ABSTRACT

The study examined linkages between formal and informal financial institutions  in  South Eastern  Nigeria.  The  area  was  purposively  chosen  because  of  the  intense  economic  activities including borrowing and savings of both the formal and informal financial institutions in this area. The objectives of the study were: to identify the financial institutions in the area and describe the operations of the formal and informal financial institutions; identify areas that formal and informal institutions were linked and the institutional factors that facilitated such linkages; determine major constraints  to linkages;  determine  strategies  that  would  enhance  linkages  between  formal  and informal financial institutions and on the basis of the findings, make recommendations for policy and further research. Multistage random sampling  procedure was used to get 36 formal and 38 informal financial institutions for the study.   Two sets of structured questionnaire for formal and informal financial institutions were  employed to collect primary data. Also secondary data were collected  on the  2007  financial  records  from  both  sectors.  The  study  was  guided  by two  null hypotheses.  Data  generated  were  analyzed  using  descriptive  statistics,  probit  regression  and exploratory  factor  analysis.  Thirty  eight  (38)  informal  and  thirty  six  (36)  formal  financial institutions were  identified. Of the twelve possible areas considered for linkages, the institutions were linked in 6 areas. Summary statistics on institutional factors that facilitated linkages   found years of business experience, interest rate on loan,  rate of loan recovery, and number of years of business  operations,      significant  factors  for  linkages  between  financial  institution.    Financial institutions grouped 5 major constraints in linking with    each other as poor legal and regulatory systems, lack of confidence, problem of communication,  poor capacity  building  and institutional rigidities.  The institutions grouped three (3) major strategies that would enhance linkages to be the provision    of    conducive    legal    and    policy     environment    to    ensure    confidence    and human/organizational  upgrading of the informal sector. In the same way the informal institutions and institutional adjustment. Based on the constraints to linkages, the following recommendations were  made;  providing  effective   judicial  system  for  protecting  property  rights  with  official recognition of informal financial institutions and their inclusion in regulated reforms; effective use of micro finance banks as second-tier regulatory body; provision of  tax relief on profits granted to banks that allocate credit through informal sector; improving the ability of banks to reduce loan losses through the use of local sanction to enforce repayment; effective networking of all informal financial institutions; human upgrading though periodic staff training and  adapting existing banks to the rural environment of informal financial institutions

CHAPTER ONE

1.1       BACKGROUND OF THE STUDY

Most business opportunities are not exploited in developing nations. Some, when started are abandoned as a result of lack of funds. The above scenario has had negative consequences on the growth of the economy. One of the major economic goals of Nigeria is a satisfactory and sustainable economic growth (NEEDS, 2004). Economic growth depends in part on efficient financial market. A financial market is efficient to the extent it brings about efficient allocation of resources including credit (Yaron, 1994).

Credit, based on sources and extent of government supervision, has been broadly classified into formal and informal (Aryeetey, 1997). The formal financial sources are those under the direct supervision of the Central Bank of Nigeria (CBN). They include commercial banks, rural banks, investment houses, insurance companies, and financing companies. These institutions have loan-able funds at their disposal. The volume of credit they give may likely meet the credit needs of borrowers who meet their lending conditions (Poyi, 2000; Mkpado and Arene, 2007). The formal institutions however have such problems as high transaction costs, low level services to customers, long and tedious bureaucratic procedures, poor information about borrowers among other weaknesses (Atieno,

1994). On the other hand, informal financial institutions have acceptable credit programmes, cheap outreach, enforcement mechanism and good information about borrowers but they do not provide enough credit to borrowers.

Information is a  major factor in  resource  allocation  in financial  market.  For instance, a lender’s willingness to lend may hinge on the information about the borrower. The absence of information may explain why lenders choose not to serve some individuals (Yaron, 1994).

Information     imperfections are important in explaining the segmentation of credit markets into formal and informal. Information flows are typically efficient over relatively close distances and within social groups, as found in the informal setting. This is one of the advantages the informal financial sector has over the formal financial sector (Bell, 1990).

The failure of formal financial institutions such as banks to serve poor borrowers is due to a combination of high risks, high costs and consequently low returns associated with such businesses. To lower these risks, banks screen potential borrowers to establish the risk of default; they create incentive for borrowers to fulfill their promises to repay; and they develop various enforcement strategies to encourage repayment, to the extent of available information.   Scarcity of information results in information asymmetries between borrowers and lenders (Varghese, 2005).   In order to address this problem, banks often attach collateral requirements to loans. Unfortunately, conventional collateral requirements usually exclude poor borrowers, who seldom have sufficient forms of conventional title.

Informal lenders have often, innovatively succeeded in limiting loan default. For instance, by lending to Self Help Groups (SHGs), the joint liability and social collateral thus created ensure strict screening and monitoring of members (Mosley 1996; Nathan, 2004). From the foregoing, each financial institution has several strengths and weaknesses. There is no unique financial institution that can provide adequate financial services to borrowers.

To  attain  financial  viability and  sustainability in  the  face  of  these  weaknesses,  the  new institutional economics and development theory suggests that formal and informal financial sectors be linked. The vision is of models, or principles that integrate both sectors; where different sectors exploit each other’s comparative advantage in cost-effectively delivering financial services to borrowers. Such integrated and partnership efforts will bring about purposeful and effective solution

to the funding of  enterprises (Miller and Berry, 2005). The concept of linkage is a financial reforms, or structural adjustment that may help expand formal credit to the informal sector in the hope that this will improve loan terms for borrowers who are shut out of the formal sector.

For  the  purpose  of  this  work,  financial  linkage  is  defined  as  any  mutually  beneficial integration or partnership; a joint venture between a formal and an informal financial institution that may result in the expansion of financial services. Operationally, a formal financial institution such as a bank is said to be linked to an informal financial institution   (Self-Help Group) where the bank provides financial support   (credit)   to the Self-Help Group. A Self Help Group such as “Isusu” collectors may   be linked to a bank through   deposits.   A bank and Self Help Groups (Isusu) are considered linked where “Isusu” clerks are employed by banks to operate as saving collectors for the bank.   An informal financial institution (Isusu collectors) is said to be linked to a formal institution where  “Isusu” collectors take loans from banks  for  lending to her own clients; where  Self Help Promotion Institute (SHPI) accepts the contractual responsibility for the repayment of members’ loan to the bank; where Self-help Group (SHG) assists banks to monitor, supervise and recover bank loans. In all these cases, there is the flow of funds and services between these sectors. This forms part of a complex system of credit-layering that exist to deal with the problems of information gathering, monitoring, collateral, and the enforcement of repayment. In this sense the two sectors are complementary.

Banks in this partnership come in as shareholders with considerable financial resources. They bring in technical expertise in the proper management of the finances and the keeping of sound records of transactions. Informal agents as shareholders bring into the management, information about the potential clients otherwise unavailable to banks. As agents, they also establish direct links with clients in order to enhance outreach through social networks, facilitate savings, provide credit delivery, increase repayment rates, develop practical and efficient ways of increasing access to credit.

Such  mutual  reinforcement  that  is  based  on  comparative  advantage  will  lead  to  economic development (Harper and Singh, 2005).

UN (1984) resolved that both formal and informal financial institutions are necessary for financing development and that linkages between them seem to be more promising than separate existence. The capacity of the financial systems could be enhanced if integrative mechanism between these sectors are developed as this may  reduce operational constraints facing each other and at the same  time  capitalize  on  the  comparative  advantages  conferred  by  each  sector  (Nissanke  and Aryeetey, 1998). Even though markets incorporate both formal and informal sectors, the system could perform its functions more efficiently if the potential benefits from specialization of each other sector could be properly exploited through linkage.

1.2       Statement of the Problem

Business exploitation, expansion and modernization depend on capital investment, given good management. Most business people in developing nations are poor and so require credit. Providing credit to poor borrowers has remained a challenge; as credit markets in these regions are faced with the problem of enforcement and imperfect information among others (Seibel, 2001). Government intervention in the form of ownership of banks, regulation and subsidization of credit has equally failed to allocate credit to poor borrowers (Udry, 1994). Institutional problems such as the lending conditions which limit access of investors to credit facilities have not been adequately addressed (Vargese, 2005). The fragmented structure of financial institutions where formal and informal sectors operate almost independent of each other is inimical to the growth of a strong and sustainable financial system (Bagachwa, 1995).

The   formal   financial   institutions   have   extensive   infrastructures   and   system,   strong management capacity, access to   funds, yet they are further removed from rural investors making obtaining adequate information and enforcing contracts imperfect and costly (Yaron 1997). In the

absence of information for instance, on the informal sectors’ ability to repay loans, the formal sectors shy away from partnership or linkages.

In contrast, informal financial institutions which operate close to rural borrowers possess enforcement mechanisms, have acceptable credit programmes, low cost of transaction, cheap outreach and good information about borrowers, but they do not provide enough credit to investors, neither have they linked borrowers to the mainstream financial sector as a result of institutional factors (Floro and Yotopoulos, 1991). Linkage arrangement will help address the information asymmetries, resolve enforcement problems, reduce cost of transaction, improve financial service delivery and hence facilitate economic development.

As micro enterprise expand in size, the volume of loan investors require becomes increasingly difficult for the informal institutions to satisfy, yet they still remain too small for the formal lenders (Aryeetey, 1997). The above scenario underscores the importance of linkage as an approach that may help  pool  together  for  sharing  the  respective  comparative  advantages  of  the  different  financial sectors. The informal sector brings to bear critical information on the creditworthiness of potential borrowers and relationship with the community that can promote timely repayment. The formal sector meanwhile can offer considerably more funds for lending than the informal lenders –a symbiotic relationship..

Legal and regulatory systems as well as property rights in many developing nations including Nigeria are unclear and often difficult to enforce making it hard for financial institutions to link up with each other. Lack of confidence among market players, poor capacity building especially of the informal sector and institutional rigidities on the part of formal sector have all militated against linkages between financial sectors.

Some studies on linkages between sectors have gaps. For instance, Alam (1989) studied areas of linkages between financial institutions in Bangladesh without the factors that facilitate such linkages.

Phelps (1995) reported on areas of linkages between sectors, leaving the constraints and strategies that facilitate such linkages. Ohabughiro (1998) and ODI (2000) in Ghana outlined conditions for linkages without strategies that will encourage effective linkages between these institutions.

This work intends to fill the above gaps by identifying areas of linkages between formal and informal financial institutions, factors that facilitate such linkages, major constraints to linkages and institutional reforms that will enhance linkages between formal and informal financial institutions in south eastern Nigeria. The basic thesis of this study is that most investors in Nigeria are poor and require credit either for initial business establishment, for business expansion or modernization.. They source for fund from both formal and informal financial institutions. These institutions have their respective strengths and weaknesses, and on their separate existence will not satisfy the credit needs of borrowers (Gallardo, Randhawa, 2005). The study is of the view that  effective linkages between formal and Informal Institution remains a strategy that will help expand formal credit to informal lenders, in the hope that this will improve loan terms for borrowers who are shut out of the formal sectors.

1.3       Objectives of the Study

The broad objective of this work is to examine the linkages between formal and informal financial institutions in South Eastern Nigeria.

The specific objectives of the study are to:

(i)        identify the financial institutions in the study area and describe the operations of the formal and informal financial institutions;

(ii)       identify areas that formal and informal financial institutions are linked, and the institutional factors that facilitate such linkages;

(iii)     determine major constraints to linkages between formal and informal financial institutions; (iv)      determine major strategies or institutional reforms that would enhance linkages between

formal and   informal financial institutions;

(v)       make recommendations for policy and further research based on findings.

1.4       Research Hypotheses

The following two null hypotheses were tested:

i.         Institutional  factors  do  not  facilitate  linkages  between  formal  and  informal  financial institutions,

ii.        The  perceptions  of  the  formal  and  informal  institutions  on  constraints  to  linkages  and strategies that would facilitate linkages are not statistically different.

1.5       Justification of the Study

The financial services industry is fragmented with little or no integration or overlap between the various sectors (SANMFI, 1998). Each of these sectors has her strengths and weaknesses and so their  linkage  or  integration  will  present  important  synergy  that  can  help  the  whole  system  to efficiently intermediate financial services to investors, especially those who are locked into a “production-credit” cycle.

The credit market in Nigeria, as in other developing nations, have much weaknesses and steps must be taken to restructure them to improve their viability (Seibel 2001). One way to achieve this is to encourage linkages between the sectors. Improvement in the financial sector is still seen as crucial to reduce poverty and limited economic opportunities. Developing effective principles or framework for linkage arrangement may make fund more accessible to investors, thereby promoting enterprise development. Linkage arrangement will open channels of communication, create common fora for the exchange of ideas and information; make for joint planning and coordination; develop practical and effective ways  for financial capacity building thereby reducing constraints of economic

activities.  It  may  help  design  government  policies  that  will  be  attentive  to  market  limitations;

introduce structural reforms that may facilitate investors’ access to credit (ODI, 2000).

The study is further justified because its findings and recommendations will be of  benefit to the following stakeholders; researchers, policy makers, operators of credit scheme. To the researcher, for instance, it will serve as a reference point, database or benchmark for further studies. The study will help financial institutions to evolve structural and operational adjustment mechanisms for a better way of channeling credit in terms of volume and time with better repayment rates. Policy can be formulated to address issues relating to training and capacity building for financial intermediaries. Effective linkages will help financial institutions to fully utilize existing institutional resources (Johnson, 2001).

The  informal  financial  institutions  are  important  sources  of  financial  relief  for  most borrowers.  The  small  volume  of  savings  they  have  do  not  afford  the  sector  enough  loans  to borrowers.  If  these  informal  sources  are  to  be  relied  upon  in  far-reaching  rural  development processes,  they  must  not  be  allowed  to  operate  completely  outside  the  formal  financial  sector (Nweze, 1994).  Combining the bank’s capital with the intrinsic advantages of the informal agents’ such as good knowledge of borrowers, small savings and loan provision, physical and social access, simple procedures, reliance on social capital and collateral, quick withdrawal and disbursement is thus a justification for linking the formal and informal financial intermediaries.


This material content is developed to serve as a GUIDE for students to conduct academic research



LINKAGES BETWEEN FORMAL AND INFORMAL FINANCIAL INSTITUTIONS IN SOUTH EASTERN NIGERIA

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