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Understanding Credit Constraints in Developing Countries: Microfinance Solutions

This text explores the characteristics of credit markets in poor countries, emphasizing demand and supply-side issues. It outlines the challenges poor individuals face in accessing credit, highlighting factors like high risk and transaction costs that hinder financial flow from rich to poor. Additionally, it discusses the role of institutional and informal lenders, the inefficiencies of subsidizing interest rates, and the emergence of microfinance as a viable solution. The examination of these dynamics is critical for understanding the potential of microfinance in improving financial access for the poor.

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Understanding Credit Constraints in Developing Countries: Microfinance Solutions

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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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