The intermediary imperative

Egyptian Spice Vendor

Perhaps this Egyptian street vendor can now get a loan. Could he also have need for a bank? (http://www.flickr.com/photos/stager57/2219225055/)

This month the World Bank loaned $300 million to the Egyptian government to pass on as loans to Egyptian micro- and small- enterprises (MSEs). Aside from the fact that bureaucrats may seek kickbacks or play favorites when disbursing loans, the move calls into question the role of donor organizations in private sector investment. Should they provide capital directly, which may encourage unsustainable donor dependency? Or should they help build capacity to enable financial intermediaries, who have a long history of providing capital and financial services to clients of all demographics?

For almost as long as banks have existed to store and protect people’s savings, they have also mobilized deposits as loans and credit, earning a profit on difference between interest received from borrowers over interest paid, if any, to depositors. This process of weaving networks between depositors and borrowers is what we now call financial intermediation, and it is a much older practice than is usually understood. There is evidence, for example, that the informal Hawala System that provides a range of financial services on an informal honor-system basis across Eurasia today has its roots in the financial intermediaries of the ancient Silk Road.

After a few generations of empires rising and falling, democracies emerging and failing, and violence waxing and waning, the formal and informal organizations that governed and conducted financial intermediation in many countries have yet to emerge or adapt to serve the modern world. While donor-infusions of capital from the World Bank and others may help some MSEs in the short term, as an unintended consequence of such infusions recipient countries may have less incentive to reform or rebuild enabling environments for financial intermediaries.

Financial intermediation is vital, especially for the poorest households in the world. Portfolios of the Poor: How the World’s Poor Live on $2 a Day was published in 2009, the result of multiple years of keeping diaries to track the intricate and dynamic financial lives of the poor. When you make $2 a day or less, income doesn’t come in a steady stream, leading to a wide variety of inter-household and community financial arrangements that run entirely outside the formal banking system.

Microfinance has evolved in the past three decades as it continues to fill in financial service gaps for such poor households. Microfinance institutions (MFIs) are now hastening to provide savings accounts in response to the needs of their clients, for example, yet most remain legally barred from mobilizing savings as capital for microloans without a commercial banking license.

Not only is it rare for an MFI to gain the right to perform financial intermediation, but other areas of the enabling environment for financial intermediaries remain cumbersome, inaccessible, or non-existent. Such areas include credit bureaus or other means to track financial histories without invading privacy, as well as functioning property systems to price collateral for larger loans.

Certainly $300 million in donor capital will make a difference for at least some Egyptian MSEs. The trouble is, that difference may also include undermining those who would like someday for the Egyptian private sector to have more accessible, sustainable financial intermediaries to mobilize its own capital.

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