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Social Capital and Finance
Contents
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Micro-finance
• Corporate finance
• Macro-finance
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Suggested reading on Social Capital and Finance
A stable, secure and equitable financial system is a precursor for sustainable growth. Poverty reduction requires effective financial organizations and instruments at the national level as well as at the household level. Social capital can affect both formal and informal financial systems.
Micro-finance
Informal
For individuals, families, and small businesses, financial institutions are a vital component of everyday economic life. Today, however, four-fifths of the world's five billion people are without access to equitable sources of credit or reliable savings facilities (Sampson 1989). In developing countries, over 90% of households are without access to institutional sources of finance (Robinson 1995).
Where formal financial institutions are absent or weak, some poor communities have devised their own mechanisms for pooling resources and lending money to those who need it (Besley, Coate and Loury 1993). Poor but closely-knit communities pledge their social capital in lieu of the material assets that commercial banks require as collateral. Social capital among the poor, in effect, "substitutes" for the services that would ordinarily be provided by formal financial institutions. These informal mechanisms, the most common of which are tontines and rotating savings and credit associations, typically involve:
groups of five to twenty people who trust each other
meetings once a week
a requirement to contribute a small sum each week to a common pot
giving the common pot to a single member each week
no written or formal contracts; all agreements monitored and enforced by group members.
Formal
Indigenous or "bottom-up" approaches to providing basic savings and credit are taken a step further by group-based microfinance programs, the most well-known being the Grameen Bank of Bangladesh (Counts, 1996). Grameen also relies on the social capital among the poor to form lending groups that monitor and enforce loan agreements, but the groups do not form of their own accord; rather, they are initiated and coordinated by "outsiders", namely Grameen staff. This adds an important second dimension to the process, since the formation and maintenance of social capital between staff and borrowers is crucial to:
identify and train borrowers
select and approve loan proposals
negotiate solutions when problems emerge (e.g. the death of a group member, crop failure following a cyclone, etc.)
fend off criticism—even hostility—from skeptics, moneylenders, and some religious leaders.
Bridging Social Capital
Another dimension of social capital illuminated by group-based microfinance programs is the extent to which successful members begin to participate in the formal economy. We know that a defining feature of many poor people is having an abundance of local social capital but a deficit of "bridging" social capital to link them to additional resources. A key challenge for microfinance programs is to draw on local social capital as a basis for forging linkages into more extensive networks and markets.
Myrada, a group-based lending program in south India, is achieving remarkable success at facilitating the difficult transition from using local lending networks to formal financial services in response to increasing capital needs (Woolcock, 1998).
Corporate Finance
Social relations are no less important to the structure and performance of large commercial financial institutions. While formal institutions rely more heavily on administrative procedures, the rule of law, and written agreements, this does not mean that social relations can be ignored.
Major business deals are typically the product of extensive personal negotiations, and companies actively seek to attract as board members those individuals who also sit on the boards of strategically related firms (Mintz and Schwartz 1985). Furthermore, as Szreter (2000: 26) astutely notes, corporate executives place an enormous
"...emphasis on the importance of exclusive informal social interactions with their peers. It is at the clubs, parties, charity events, [private] school functions and holiday visits of the wealthy and the super-wealthy that they do some of their most important business. They know that establishing friendship and relations of trust with a network of others who are in a position to share and exchange the most valuable informal information is one of the most efficient and reliable ways to make spectacular gains in a market economy."
Macro-Finance
Similarly corporations, public sector institutions can also function more efficiently due to certain forms of social capital (La Porta et al, 1997).
Taiwan and South Korea enjoyed rapid growth from the 1960s to the early 1990s in part because of the size, stability, and strength of their financial institutions, and their close association with selected export industries (Haggard and Lee 1995; Rodrik 1996).
In a globalized economy, the financial health of a nation is heavily impacted by international capital flows. Attracting and maintaining foreign investments are not solely dependent on interest rates – social cohesion is used by investors as an indicator of fiscal stability and a sound investment climate (Rodrik 1997).
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