Lecture 3: Financial Market Problems and Microfinance Contract Innovations

Question 1

ROSCAs: again

Answer 1

ROSCAs are based on sharing resources with a group of neighbours and friends.

• For example, 20 people may agree to contribute $15 each for twenty months, generating a monthly pot of 20 × $15 = $300. * The group meets to collect dues at monthly intervals and allocate the proceeds until every member has had a turn with the $300 pot * Past recipients excluded from getting the pot again. * Unless it is a “bidding” ROSCA.

ROSCAs show a way to formalize the use of groups to allocate resources in poor communities.

• But their simplicity can also be a disadvantage. * Many use ROSCAs largely as a way to save, rather than as a means to borrow.

Question 2

ASCA: Accumulating Savings and Credit Associations

Answer 2

An ASCA is essentially a credit cooperative. * Or, credit union

In an ASCA, all members regularly save the same fixed amount while some participants borrow from the group.

ASCA, a modification of ROSCA, thus allows * Some participants to mainly save, and * Other participants to mainly borrow

• Members do not have to wait their turn to borrow * Participants (savers and borrowers) are all shareholders * Key decisions (interest rates, loan size) are determined democratically * Cooperative acts like a guarantor and peer-monitor.

Question 3

3 KEY Asymmetric information problems

Answer 3

• Adverse Selection: How to screen out bad “types” of borrowers?
• Ex-Ante Moral Hazard: How to screen out borrower with risky/bad investment ideas?
• Ex-Post Moral Hazard: How to make sure that the borrower puts enough effort into his project, so that it succeeds, and she/he does not default and walk away?

Question 4

Joint liability group lending

Answer 4

• Joint liability * Immediate start of repayment (from first week on) * Frequent repayments (usually weekly) * Zero-tolerance policy to late repayment

Responsibilities include * Screening potential customers, * Monitoring their efforts, and * Enforcing contracts.

Group lending refers to arrangements made by individuals without collateral

• This method is known as ‘2:2:1 staggering’ at 4-6 week intervals. * Over time, though, formal sanctions became more common. * In principle, if serious repayment problems emerge, all group members will be cut-off from future borrowing. - * Joint liability → Formal sanctions in case of default

Question 5

assortative matching

Answer 5

Safe borrowers have to group with other safe borrowers. * Risky borrowers have to group with other risky borrowers. * Thus, risky borrowers help cover the defaults of their peers

Question 6

Disadvantages of ROSCAs

Answer 6

Borrowers are increasingly frustrated at the cost of attending regular meetings,

• Loan officers refusing to sanction good borrowers who happen to be in “bad” groups, and * Constraints imposed by the diverging ambitions of group members.