Transaction costs include all the costs associated with executing and governing a transaction. Since formal financial transactions are recorded in writing, and written records are the principal source of evidence in the case of disputes, people who can't read or write will avoid formal finance unless they receive their money first (as in the case of a loan, or a cash withdrawal).
"A governance structure is usefully thought of ... as an institutional framework in which the integrity of a transaction, or related set of transactions, is decided." [Oliver E Williamson]
When transactions fail to attain integrity, in the sense of a common agreement between the buyer and sell, markets fail. And in the case of microfinance, this means financial exclusion.
Dear Brett Matthews
The position of the formal banks (mainstream finance) is credit rationing, they are avoiding problems of illiteracy, fongibility, distance (transaction cost as most of the poor live in remote areas), and others. So, financial inclusion has to deal with a lot of factors. Meanwhile, the poor have their own financial system which is informal for some.
Emmanuel Rémilien Formal banks are a long way above this market, which 'only' affects the poorest billion adults world-wide. I have observed that savings group members are more likely to be literate than the other villagers around them, when written records are part of the savings group. Microfinance institutions in the 1960s and 1970s mostly gave up on savings, because savings products cannot build trust with non-literate customers, who can't read the statements, or correct errors in real time as records are made.
Literate individuals will use both loans and savings, whether formal or informal. If there is no bank due to distance, they will use what is in the village. In other words, neither the saving nor the loan market will fail for the literate segment.
Illiterate individuals will use loans in certain difficult circumstances, but savings markets will largely fail if written records are required - whether savings are offered by formal or informal entities. There are ways to work around this - like the 'savings collectors' in Ghana. But there are huge expanses of the world where this market is still failing.
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