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Credit Constraints

Credit Constraints. A first approach to the “microfinance solution”. 1) Characteristics of credit markets in poor countries. Demand side : fixed capital, working capital, consumption ….. (not very different from those in developed countries) Supply side : -Institutional lenders

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Credit Constraints

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  1. Credit Constraints A first approach to the “microfinance solution”

  2. 1) Characteristics of credit markets in poor countries • Demand side: fixed capital, working capital, consumption ….. (not very different from those in developed countries) • Supply side: -Institutional lenders -Informal lenders in response to informational asymmetries In turn has led to: Segmentation, Interlinkage, Interest Rate Variation, Rationing, Exclusivity which in turn led to various “theories” of informal credit markets • But let us see the “big picture” first….

  3. 2) Why credit does not flow from rich to poor After all, Neoclassical theory would suggest….

  4. At least two reasons why this may not be so:First

  5. Second

  6. In either scenario the poor cannot pay high interest rates Moreover: And interest rates faced by the poor would be exceedingly anyway for 2 Main Reasons: • High Risk • Huge Transaction Costs

  7. 3) Can’t the poor borrow? In principle, the answer is yes. As mentioned earlier, from institutional sources, and from informal sources Institutional sources, mostly development banks, where credit was subsidized. Concerns: Politics, corruption… Pushed out informal credit suppliers No incentives to collect poor individuals’ savings

  8. Informal sources. Problems: • Astronomically high interest rates • Not enough savings to mobilize And subsidizing interest with outside sources of credit via institutional sources was inefficient In the mid – 1970s, in Bangladesh….

  9. Microfinance • Building on informal credit institutions → Transaction costs ↓ → Interest rates were ↓ → Repayment Rates ↑ In turn, a demonstration to donor agencies that lending to the poor could be efficient, and potentially profitable too!! → Next class: A-M (2005), Chapter 2

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