Introduction to Micronance

November 2007

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Introduction

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The Nature of Micronance

Microcredit: collection of banking practices built around small loans,
typically with no collateral
Micronance: also includes eorts to
,! stimulate savings
,! provide insurance facilities
,! distribute and market clientsoutput
Programs exist worldwide
,! well-established programs in Bangladesh, Bolivia and Indonesia
,! new programs in Mexico, China and India
,! villages along the Amazon
,! inner-city Los Angeles, Toronto and Halifax
Over 70 million clients (grown at 40% per year since 1997)

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The Grameen Bank: The Beginnings of Micronance

Started by Mohammed Yunus (1976) with help from Bangladesh Bank
Later helped by IFAD, Ford Foundation and several governments
Basic group lending mechanism (Grameen I):
,! groups of 5 formed voluntarily
,! 2:2:1 staggering at 4-6 week intervals
,! cycle continues as long as loans are repaid
,! repayments made weekly in public
,! joint liability
,! progressive lending
Initial analysis attributed success to role of "joint liability"
More recent analysis emphasizes other aspects
,! dynamic incentives
,! high frequency repayment schedule
,! 95% female borrowers
,! current movement towards individual lending (Grameen II)
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Adverse Selection and Joint Liability

Can group lending make it possible to "implicitly" charge safe

borrowers lower interest rates and keep them in the market?
Joint liability ) incentive for "assortative matching"

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Example: 2 member group

One-period project requiring $1 investment

Banks cost of $1 loan = k
Fraction q of borrowers are "safe": gross return = y
The remaining 1

q are "risky":

Gross return =

y with prob. p
0 with prob. 1

Indentical expected return: p y = y

Borrowers know each others types, but lender doesnt
Assortative matching ) a fraction q of groups are (safe, safe)

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If both types of borrower are in the market, what is the break-even

repayment, R b ?
,! assume that y is large enough that y > 2R b
Then the probability of repayment by a risky pair is
g

= 1 (1 p )2
= 2p p 2 > p

since default occurs only if both members fail

) break even repayment:
R b =

k
q + (1 q )g

This must be less than the minimum repayment without group lending
Rb =

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k
q + (1 q )p

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Implications

In this case risky borrowers can repay more often

,! risk is transferred from bank to risky borrowers

,! allows bank to lower interest rate and still break-even
,! safe types may be lured back into the market

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Moral Hazard and Peer Monitoring

Joint liability ) incentive for members to impose sanctions on each

other to induce more eort

) relaxes IC constraint ) more projects will be funded

Can also help to overcome enforcement problem
Relies heavily on use of "social sanctions"

,! is this realistic ?
,! is this a good thing ?

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Problems with Group Lending in Practice

Mixed results across countries reects dierences in trade-o between
benets and costs
Groups may be di cult/costly for borrowers to set up
Attending group meetings can be costly in some cases; benecial in
others
Transfers risk from bank to borrowers
Beyond a certain lending scale, individual contracts may be preferred
Social sanctions for default often seem too harsh and/or not credible

,! what if the defaulter has trouble through no fault of her own?

,! punishment imposes a "deadweight loss"

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Beyond Group Lending

Emerging view: joint liability is often not the main key to success
Shift toward individual lending for the "not so poor"
Grameen II proposal
Emphasis on dynamic incentives to induce repayment

,! e.g. progressive lending

,! a key element of Grameen bank lending

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Progressive Lending (two period example)

Invest L to get output y = AL > L
Let = discount factor
Let v = probability of being renanced despite default
gross borrowing rate = R
IC constraint for xed L
AL

RL + AL

AL + vAL

) lenders maximum repayment:

R = A(1

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v)

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Suppose loan grow by a factor > 1 between periods

IC constraint
RL + AL

AL

AL + vAL

) maximum repayment
R

= A(

v) > R

If R < r < R , loans will be made that previously werent

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Implications

Progressive lending can help to relax borrowing constraint

But, in a multi-period context, borrower may choose to default once
loan size becomes large enough

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Privatization of Micronance ?
Presented as a market-based strategy for poverty reduction, but
continues to be heavily subsidized
Intended strategy: subsidies initially, then operate without them once
scale economies and experience drive down costs
Need to attract savings, issue bonds or obtain commerical funds
In July 2002 Financiera Compartamos (ACCION) issued a 100 million
peso bond
,! to get A+ rating from S&P, lending rates exceed 110%
Why worry about high rates if enough borrowers can pay them?
,! complementary inputs
,! increasing returns at low levels
To serve the poorest, subsidies may be essential

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