Bank-NGO linkages and the transaction costs of lending to the poor through groups

Paul McGuire | John Conroy

The Foundation for Development Cooperation's 'Banking with the Poor' project stresses the importance of linkages between commercial banks on the one hand, and non-government organizations (NGOs) and self-help groups of the poor (SHGs) on the other, as a mechanism for channelling credit
to the poor on a sustainable basis. In addition to offering a number of other advantages, such 'linkages' can reduce the transaction costs of lending and borrowing. This article describes two studies, one in India and one in the Philippines, which set out to quantify the transaction costs
of commercial banks and NGOs in lending to the poor, and the transaction costs facing poor borrowers. The Indian study compared the transaction costs incurred by banks when lending to the poor through various channels, and found that transaction costs were much lower where banks used NGOs
and SHGs as intermediaries. Transaction costs facing borrowers were also significantly lower. This suggests an important role for NGOs in the intermediation process.The Philippines study looked at the question from the perspective of the NGOs. It found that NGOs could channel credit to
the poor with lower transaction costs, as a proportion of loans granted, than most other institutions. Nevertheless, the small loans and short maturities inherent in lending to the poor inevitably led to transaction costs being relatively high compared to the value of loans outstanding at
any one point in time. This highlights the need for NGOs to minimize costs as far as possible, and the article includes a number of measures that would help them to achieve financial sustainability.