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

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

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

5. 5 Second

6. 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: a)High Risk b)Huge Transaction Costs

7. 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. 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. 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