Originally posted December 2009

Building legitimate institutional structures which facilitate inclusive development and deliver effective governance is central to stability in Afghanistan. How to do this is the daunting question which has stymied progress toward prosperity and peace. Examining rhetoric and practice around building legitimate institutions illustrates that legitimacy is often linked with formality. This can leave informal institutions neglected, even if that is where legitimacy and trust may already lie. This essay contends that this formal/informal divide is misleading, and that privileging the formal is detrimental to efforts to develop legitimate and effective structures. Instead, understanding how informal institutions have worked, and building from them, may be a more appropriate way to increase Afghan ownership and improve the sustainability of any reforms made.

Formal/informal Divide

To be formal is to be official, recognized, and registered, to be part of the accepted system, from the point of view of bureaucratic procedure and structures. According to some, these characteristics provide formal institutions legitimacy and a privileged role in development.[1] Informal institutions are defined based on what they are not (i.e., formal). In this way, they tend to be the discounted and devalued part of the binary opposition, and identified as quite separate from their formal counterparts.

This division of the formal and informal, and the tendency to value the former over the latter, means that what informal institutions offer tends to be overlooked. This is particularly the case in the Afghan context where informal structures are what sustained populations through decades of conflict and weak governance. Local systems of social protection, social control, and rule of law delivered for people — not without flaws, but in ways that have become understood and trusted. In this context, imposing formal institutions may be counterproductive, particularly if no effort is made to assess what systems already exist, how they function, and what can be improved. Formal institutions may reduce human security if they intervene in existing systems without understanding the potential for unintended consequences, leading to dissatisfaction and growing mistrust.

The division of the formal and informal not only devalues informal systems which may be highly functional, but it also tends not to mirror reality. Evidence shows that in practice formal and informal systems become entwined. Not recognizing this can be problematic, as illustrated below through a study of interventions in Afghan rural credit markets.

Informal Credit, Microcredit, and Livelihood Security

The effects of separating the informal and formal are readily apparent in the case of credit systems in Afghanistan. AREU research shows that this false division, and particularly a disregard for informal credit systems in the process of introducing microcredit (MC), led to increased vulnerability in rural contexts, which can in time become a destabilizing factor.[2]

Devaluation of and disregard for informal credit systems in Afghanistan were apparent in how microcredit was introduced in 2003. The rhetoric justifying investment in MC was that Afghans, and particularly rural residents, lacked access to any credit facilities. Therefore, there was an extensive unmet demand for credit which MC services could fill. This presumed that the credit market was a blank slate, lacking any competitive products. Evidence from AREU’s research suggests that this presumption was false. Access to credit was not, and is not, currently lacking. Informal credit markets exist and provide significant amounts of credit for both consumption and investment purposes, in some cases in amounts equal to average loans sizes from MC programs. The unwillingness to acknowledge the presence of an informal credit system, which continues today, has several consequences.

First, MC was clearly an additional — not the only — source of credit, meaning that lack of access to credit was insufficient justification for the expansion of formal credit systems to rural Afghanistan. MC entered a credit market operating with considerable complexity, in which its products had to compete with what the informal system offered in order to retain clients and ensure positive livelihood impacts. Microfinance institutions (MFIs) need to invest in understanding the nature of the market they are entering and design products which meet client interests.

However, those who initially developed MC programs in Afghanistan did not factor informal credit systems into their thinking. MFIs made little to no assessment of existing informal markets and their strengths and weaknesses in considering potential client demand, developing MC products, or deciding in which areas to provide MC. This lack of information gathering about informal credit systems was a significant gap, because good product design depends on knowledge of the context and customers. Investing the time to understand local credit systems can lead to more responsive and innovative MC products, which are more widely accepted and legitimate. This can improve MFI and client livelihood viability, supporting local development. Inattention to this step meant MC programs faltered; they are currently going through a significant reform process, including reassessing products offered.

Disregarding existing informal credit systems also results in a lack of knowledge of how formal and informal credit systems interconnect and how this may affect client debt levels and repayment capacity. AREU’s research identified clear linkages between formal and informal credit systems in its study villages. Often these links started from a need to find the money to meet a MC repayment deadline, with many borrowers turning to informal sources because they had not been able to earn enough return from the loan’s investment activity to meet both consumption and repayment needs in the timeframe allotted by the MC program. Since most MFIs measure their success through repayment rates, informal credit systems supported the success of MC through enabling repayment. This hid increasing client debt burdens and how MFI viability improved at first, while client livelihood security deteriorated.

A third problem with disregarding the existence of informal credit systems is misunderstanding the meaning of credit in rural Afghanistan. Like informal credit exchanges, microcredit borrowing is often about more than the money. Though MFIs conceive of MC as a market-based financial transaction, respondents in AREU’s study perceived it differently. They embedded their understanding of the role of MC within existing social relations and used MC as another tool with which to create or strengthen social ties. This should come as no surprise, given the importance of social networks to livelihood security in the Afghan context. Social relationships form the social protection system through which people survived the many phases of conflict in the absence of state support, and this continues today. By not recognizing the social dimensions of microcredit and informal credit in Afghanistan, MFIs run the risk of not fully understanding how their programs operate on the ground, why they may or may not be successful, and how they may influence client livelihood strategies in unanticipated ways.


The case of credit systems in rural Afghanistan points to the need to understand informal institutions, since they may provide the best point of departure for new interventions. Imposing formal systems which may lack the legitimacy of existing informal institutions may be inefficient at best and counterproductive at worst. The key is to take the time to understand what institutions have legitimacy and what improvements in equity, access, or outcomes are needed in order to ensure new systems enhance instead of detract from human security and stability.

[1]. World Bank, “Afghanistan: State Building, Sustaining Growth, and Reducing Poverty,” Report No. 29551-AF (Washington, DC: World Bank, 2004).


[2]. Case study material is drawn from Paula Kantor, “From Access to Impact: Microcredit and Rural Livelihoods in Afghanistan” (Kabul: AREU, 2009); Floorje Klijn and Adam Pain, “Finding the Money: Informal Credit Practices in Rural Afghanistan” (Kabul: AREU, 2007); and Paula Kantor and Erna Andersen, “Building a Viable Microfinance Sector in Afghanistan” (Kabul: AREU, forthcoming).