Informal Finance in Sierra Leone: Why and How It Fits Into the Financial System

This paper investigates why in Sierra Leone the informal financial sector continues to exist alongside the formal financial system, despite the implementation of financial sector reforms. One of the main policy objectives of the expansion of formal finance in developing countries is to curtail the use of informal finance because of the associated downsides of its use. However, a number of studies have found that large informal financial sectors still exist in sub-Saharan African economies.

Cognizant of the existing theories of informal finance, this paper seeks to examine the context-specific reasons for the continued relevance and use of informal finance in Sierra Leone. The paper finds a number of factors account for the prevalence of informal finance in Sierra Leone including; historical and social factors, external factors beyond policymakers' control, and problems with government and donor efforts to promote rural banking and the expansion of the microfinance sector. Perhaps most thought-provoking is that a degree of interdependence exists between formal and informal finance as they both feed off each other, a finding which has implications for policies aimed at curbing the use of informal finance.