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Abstract:
The last fifty years have seen the large-scale implementation of financial programs that specifically target the
poor. Many such early programs, often implemented by governments, were not able to satisfactorily deal with
information uncertainties, and hence resulted in weak incentive structures, heavily bureaucratic and politicized
approaches and inevitably low repayment performance. More recently (even though the concept is more than a
century old), a new type of approach to lending to the poor—known as microfinance—has designed specific
methods to deal with information uncertainties, resulting in impressive program performance. Almost
concurrently, social scientists and development practitioners have identified and assembled growing anecdotal
evidence to suggest that the forms of capital traditionally used in growth theory (natural, physical and human)
are missing an important element. This concept, generically known as “social capitalE includes the various
networks of relationships among economic actors, and the values and attitudes associated with them.
A large part of the success of microfinance programs resides in their ability to surmount the significant
information problems inherent in dealing with poor customers with no banking experience and unknown
creditworthiness. Hence this literature review examines how social capital can help reduce the cost of imperfect
information in small financial transactions, and thereby improve the performance of credit delivery programs in
the developing world. It will suggest that, although social ties facilitate the poor’s access to credit and lowers its
cost, they do so in a more diverse and complex manner than the mainstream literature on development finance
indicates. In addition to the horizontal networks of borrowers that are largely credited for the success of
organizations like the Grameen Bank, credit delivery systems also rely heavily on vertical and/or hierarchical
relationships between lenders and borrowers.
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