Topic 8 - Financial Services and the Poor Flashcards Preview

20ECC119 - Development Economics > Topic 8 - Financial Services and the Poor > Flashcards

Flashcards in Topic 8 - Financial Services and the Poor Deck (31)
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1
Q

What is the Generic Lender Problem (considering why capital mkts are imperfect)?

A

Asymmetric Infor among parties involved implies opportunistic behaviours

  1. Adverse Selection (AS)
  2. Moral Hazards (MH)
2
Q

What does the Adverse Selection mean for finance (HIDDEN CHARACTERISTICS)?

A

->Lending: lender cannot properly select only good borrowers (or adjust the interest rate to the
borrower’s riskiness).

->Insurance: more risky people will tend to seek insurance, raising the cost of payments for the insurance company that cannot recognize them before

3
Q

What does the Moral Hazard mean for finance (HIDDEN ACTIONS)?

A

->Lending: lender cannot observe or cannot enforce the proper use of funds and repayment by the
borrower.

->Insurance: insurer cannot prevent the insured from behaving more recklessly and increasing the
likelihood of accidents, knowing that s/he is now insured.

4
Q

What are Micro Finance Institutions?

A
  • Fin services for the poor (Small loans like $200)
  • Also offering support to help toward the goal
  • When started as a circle where people pooled money together, one person would take and pay back and the other would take and pay back
5
Q

What are the 4 problems lenders need to solve in order to obtain prepayments?

A
  1. Adverse selection (AS) in choosing borrowers;
  2. Monitoring of project choice and implementation to prevent moral hazard (MH);
  3. Providing insurance in spite of the risk of MH;
  4. Enforcement in repayment to avoid MH (strategic default).
6
Q

What is the Selection Problem?

Avoid AS of borrower.

A

->Lender has difficulty in screening ex-ante good from bad borrowers due to incomplete and
asymmetrical information
->Cannot fully know if the borrower will be able and willing to repay the loan.

7
Q

What is the Monitoring Problem?

Avoid MH in project implementation.

A
  • > Lender cannot closely monitor (even if he could observe) the borrower’s behaviour
  • > Cannot be certain if borrower will make good use of the loan so that she will be able to repay
8
Q

What is the Insurance Problem?

Provide insurance and avoid MH in insurance claims.

A
  • > Poor borrowers need some form of insurance against unexpected shocks.
  • > Lender cannot easily distinguish genuine failures from false claims due to imperfect information
9
Q

What is the Enforcement Problem?

Avoid MH in loan repayment

A
  • > Lender cannot easily force the borrower to repay.
  • > Does not know if the borrower will be willing to repay, even if he is able to do so having made successful use of the loan.
10
Q

What are the implications of barriers to finance for the poor?

A
  • > Capital-market exclusion - Lack of access to traditional capital markets
  • > A vicious circle whereby poverty reproduces poverty
11
Q

STATS ON MFI NUMBERS

A
  • > BRAC in Bangladesh, with 4.2 million borrowers, 5.8 million depositors, and offices in 14 countries
  • > Bank Rakyat in Indonesia with 2 million borrowers and 16 million depositors;
12
Q

Why are sums of money needed by households?

A

(1) meet life cycle needs such as dowries, school fees, and burial costs,
(2) face emergencies such as doctor fees and hospital costs,
(3) acquire indivisible assets such as livestock, land, housing, and durable goods, and
(4) invest in business activities requiring capital goods and inventories (Rutherford, 2000).

13
Q

What are the issues in typical commercial banks and local money lenders?

A

Commercial banks:

  • > Requires collateral overcome the problems of selection, monitoring, and enforcement.
  • > Access to credit is restricted

Implications:
 An Efficiency cost
 An Equity cost.

14
Q

What are Informal MFIs (Rotating Saving and Credit Association) (ROSCA)?

A
  • > Group of individuals acting as an informal financial institution
  • > Set contributions and withdrawals to and from a common fund.
15
Q

What are some key features of ROSCAs?

A
  • > Better option when expenditures can be planned or their timing is not too important;
  • > Spontaneous associations (generally exist without any formal by-laws).
  • > Promote BOTH Savings and Access to lump sums
  • > Typically at the grassroots level.
16
Q

What are some advs and disadvs of ROSCAs?

A
  • Able to sort issues of selection and enforcement
  • Social commitment to repay
  • Promotes savings
  • Gives commercial bank proof that you are a consistent saver
  • May not have access to money when needed (if not your turn)
  • Issue of those who just finesse the money
17
Q

What are MFI’s with group lending working arrangements?

A
  1. Replacing the use of assets as collateral (which the poor do not have), with social collateral (which the poor can provide).
  2. Pioneered by the Grameen Bank in 1970.
  3. Loans are individual, but group members jointly liable.
  4. Group serves as social collateral, Inherent incentives to repay
18
Q

What are the pros and cons for the poor about MFIs with group lending?

A
  • Covers Selection, Monitoring, and Enforcement issues addressed (via group support)
  • Insurance (except covariance risk that impacts the whole community)
  • Affords them loans they couldn’t otherwise
  • Dynamic incentives, where incentives to repay are generated by granting access to future loans

NEG:
- Risk of putting everyone in fin trouble if one defaults

19
Q

How do Village Banks work?

A

CHECK GRAPH

Usually between 200-400 people formal by-laws

20
Q

How do Self-Help Groups (SHG) work?

A

Usually composed of 10–20 local (mostly) women.
Deals with Selection, Monitoring, Enforcement issues (via social pressure)
Covariate risk can be a problem as with Village banks

Essentially, group comes together to deposit in bank and take bigger loans etc.

21
Q

Advs and Dis of Self-Help groups

A

Adv.

  • Network
  • Connection between people and banks
  • Dynamic incentives

Dis.
-MFI dealing with people as individuals not as a group (tasking and need to check about members more often)

22
Q

What are Proximity Lending MFIs?

A
  • Loans typically by profit-oriented MFIs
  • Sits somewhere between the commercial banks and the Village Banks.
  • Profitable as long as interest rates are high, repayment rates are also high, and there is little
    competition
23
Q

Advs and Dis of Prox Lending MFIs?

A

Adv.
- Lump sum

Neg.

  • Defaults
  • High interests (like loan shark) since profit motivated
24
Q

How do MFIs get high repayments without collatoral?

A

3 instruments used.

  1. Dynamic incentives
  2. To require co-signers
  3. Proximity Lending

Partially covers 4 generic problems for lenders – selection, monitoring, insurance and
enforcement.

25
Q

Why would the poor need some kind of insurance in MFIs?

A
  • Because of the risk of default (might lose whatever assets)
26
Q

Why are traditional insurance providers not compatible with the poor?

A
  • Difficult to verify whether you need the insurance money (i.e leak in roof to cover) since looking at bottom of the pyramid
  • Lots of people for small sums (not worth it to send someone over)

-> Traditional schemes dont bother with poor

27
Q

Why is traditional insurance schemes not compatible with the poor?

A
  • Risk management strats.
    May not take the costly insurance and instead play it safe to pay off credit. Meaning missing out on potential big pay off
  • Risk Coping Strats.
    Would rather pay off credit with own assets than take expensive insurance.

This leads them to not even take the credit.

28
Q

What is Index Based Insurance?

A

Insurance that pays you out if you don’t get affected

For instance, if a region gets less rainfall than anticipated at a decided upon cut-off point then full pay out back to those paying into the insurance

Usually done with weather, drought, rain etc.

29
Q

Why is Index Based Insurance not perfect?

A
  • Individuals may experience something that the weather station won’t record
  • Partial protection since the insurance is broad covering
  • May not cover against other issues. I.e someone build something that cause drought (other shocks not inc) -> More issues, more money (issue)
30
Q

Have MFIs helped?

A

MFI helped reduce credit-mkt failures of many inc women who constitute 97% of Grameen bank clients and 98% of those in Compartamos Clients (Mex)

-> Banerjee: evaluations
(with proper counterfactuals) tend to show more modest results than are claimed by the advocates
of microfinance

31
Q

What are the features of Proximity MFI’s?

A
  1. The use of dynamic incentives i.e. loans given in graduated amounts,
  2. Borrowers often require a co-signer to vouch for them, as you rightly point out. A form of a guarantor.
  3. Borrowers are usually ‘recommended’ by a credit agent, who often lives within the community and who gets a commission when his/her recommended borrowers repay their loans in time.
    a, So these credit agents have a vested interest in recommending credible and well-behaved borrowers who will repay and not ones who will abscond.
    b. Sometimes they also share their ‘ratings’ with other credit agents (usually through a Credit Bureau).