Financial instruments are legally recognized documents that have monetary value. Examples are bonds, equities, debentures, shares, and checks. Informal financial instruments are agreements made to exchange finances without reference to the legal restrictions. These are mainly used among people who do not have access or cannot afford formal systematic savings credit facilities. Some of the items used as informal financial instruments are check-cashing outlets, loans from friends, saving clubs, pawn shops and money lenders. Advantages include low interest rates, immediate accessibility, approval of loans based on character and sequential access to facilities.
Reduced Costs of Transactions
The cost of transacting informal financial instruments is usually lowered by the direct interactions between sellers and buyers. This is because the borrower deals directly with the lender and in so doing eliminates the long clearance procedures and costs associated with brokers. For example, when it comes to saving, informal financial instruments do not have additional charges for storing the money. Interest rates charged on informal financial instruments are another advantage, given that they are relatively lower than rates of formal financial instruments. Another factor that saves money is the absence of transactional charges and clearance procedures that increase the cost. The reduced costs make this service suitable to individuals who are already constrained financially.
Informal financial instruments are accessible to all because they do not have official criteria of qualifying those applying for the service. A transaction involving informal financial instruments may be completed within minutes of applying. A simple cash receipt or verbal agreement is all that is needed to complete the transaction. Also, there is no need for any special preparations or documentation to present to the lender for a loan application to be approved. Convenience also involves the variety of people who can access the informal financial instruments in addition to the items that may be used as security when security is requested.
With informal financial instruments, the circumstances surrounding the applicant are considered when the financial assistance is being offered. This offers the advantage of having special considerations even when the criteria for lending are not met. Informal financial instruments do not have a set standard to measure up to when the financial services are needed, and therefore they are able to offer flexible services according to individual needs.
Variety of Service Offerings
Informal financial instruments offer diverse services such as loans, credit, leasing, savings, and insurance. The agreement on each transaction varies and therefore negotiation plays a major role in determining the service someone is offered. Although the predominant service is loaning, saving clubs enable the members to accrue their finances for a specified period and they are not allowed to withdraw any amount of money until the period elapses.
There is no limit to the number of times an individual may come back for financial assistance in the informal financial instruments as long as the borrower is able to come to an agreement with the lender. For example, when the funds run out before a project is completed or sales are realized, the borrower may go back to the lender and acquire additional funds as long as evidence is provided to show the progress made with the previous financial assistance.
- “Intelligent Investor: A Book of Practical Wise Counsel”; Benjamin Graham; 2003
- Microfinance: Informal Finance and the Design of Microfinance; Mark Schreiner; November 2000
- University of Chicago: Informal Financial Networks: Theory and Evidence; Mark J. Garmaise et al
Paul Merchant started writing in 2005. His articles have appeared in “JSTOR Journals” and “Wileys Management Journals.” He is a certified public accountant and a qualified project management expert. Merchant holds a Bachelor of Arts in communication from the University of Nairobi.