Topic 8 - Financial Services and the Poor Flashcards
What is the Generic Lender Problem (considering why capital mkts are imperfect)?
Asymmetric Infor among parties involved implies opportunistic behaviours
- Adverse Selection (AS)
- Moral Hazards (MH)
What does the Adverse Selection mean for finance (HIDDEN CHARACTERISTICS)?
->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
What does the Moral Hazard mean for finance (HIDDEN ACTIONS)?
->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.
What are Micro Finance Institutions?
- 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
What are the 4 problems lenders need to solve in order to obtain prepayments?
- Adverse selection (AS) in choosing borrowers;
- Monitoring of project choice and implementation to prevent moral hazard (MH);
- Providing insurance in spite of the risk of MH;
- Enforcement in repayment to avoid MH (strategic default).
What is the Selection Problem?
Avoid AS of borrower.
->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.
What is the Monitoring Problem?
Avoid MH in project implementation.
- > 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
What is the Insurance Problem?
Provide insurance and avoid MH in insurance claims.
- > Poor borrowers need some form of insurance against unexpected shocks.
- > Lender cannot easily distinguish genuine failures from false claims due to imperfect information
What is the Enforcement Problem?
Avoid MH in loan repayment
- > 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.
What are the implications of barriers to finance for the poor?
- > Capital-market exclusion - Lack of access to traditional capital markets
- > A vicious circle whereby poverty reproduces poverty
STATS ON MFI NUMBERS
- > 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;
Why are sums of money needed by households?
(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).
What are the issues in typical commercial banks and local money lenders?
Commercial banks:
- > Requires collateral overcome the problems of selection, monitoring, and enforcement.
- > Access to credit is restricted
Implications:
An Efficiency cost
An Equity cost.
What are Informal MFIs (Rotating Saving and Credit Association) (ROSCA)?
- > Group of individuals acting as an informal financial institution
- > Set contributions and withdrawals to and from a common fund.
What are some key features of ROSCAs?
- > 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.
