This paper argues that borrowers who are considered to be too risky are excluded from microfinance markets due to credit rationing. Insufficient institutional frameworks imply moral hazard which in turn causes the rationing of credit. Focusing on outreach and pricing issues, it is shown here how the outreach of microfinance depends on capital costs and subsidization. Capital costs worsen credit rationing and the extent to which subsidies mitigate the effects of credit rationing on outreach is typically limited. Market structure has no direct effects on credit rationing but affects the availability of credit through client maximizing cross-subsidization. Consequently, attempts to improve the outreach of microfinance through subsidization and changes in market structure are believed to have little effect. Instead, it is advocated that institutional changes reduce moral hazard and thus credit rationing…
Contents
1 Introduction
2 Background
2.1 Definition of microfinance
2.2 Some characteristics of credit markets in developing countries
2.2.1 Legal system in developing countries
2.2.2 The function of the legal system in rural credit markets
2.2.3 Collateral
2.2.4 Predatory interest rates
2.3 Description of credit institutions in developing countries
2.3.1 Formal banks and financial markets
2.3.2 Microfinance institutions
2.3.3 Moneylenders
2.4 Microfinance institutions
2.4.1 The microfinance market
2.4.2 Enforcement methods
2.4.3 MFI objectives
2.4.4 Self-sufficiency and subsidization
3 Theory of credit rationing
3.1 Credit rationing
3.2 Adverse selection
3.3 Moral hazard
3.4 Other research
4 Model
4.1 Definitions and assumptions
4.1.1 Credit rationing
4.1.2 Repossessable asset
4.1.3 The outcome of the projects
4.1.4 Constraints
4.1.5 Types of borrowers and institutions
4.2 Base case
4.2.1 Without credit rationing
4.2.2 Introducing credit rationing
4.2.3 Monopoly
4.2.4 Client-maximization
4.2.5 Introducing competition
4.3 Introducing a cost of capital
4.3.1 Monopoly
4.3.2 Competition
4.4 Subsidies
4.4.1 Monopoly
4.4.2 Competition
4.5 Effects on the critical level of risk
4.5.1 Market structure
4.5.2 Cost of capital and subsidies
4.5.3 βi as collateral
5 Outcomes and implications
6 Microfinance in Vietnam
6.1 The rural financial sector in Vietnam
6.2 Credit rationing on the Vietnamese microfinance market
6.3 Moral hazard in Vietnam
6.4 Desired legal and institutional reforms
6.5 Correlation between interest rate and borrower risk
7 Conclusion
8 References and readings
8.1 References
8.2 Readings
9 Appendices
Author: Katarina Kahlmann, Fredrik Odeen
Source: Stockholm School of Economics