Week 9: Microfinance

Question 1

Stylised facts (8)

Answer 1

Borrowing is widespread & frequent among poor despite not having access to formal credit.

Lending rates much higher than deposit rates

Extreme variability of interest rates

Low levels of default

Ex-Ante competition in credit markets

Borrow to maintain business (not expand)

Rich borrow more, and interest less

Borrow and save at same time

Question 2

So if they borrow but often no formal credit, where from?

(According to Poor Economics 18 country dataset)
(name 3 sources, 4 ncluding formal)

Answer 2

66% people had a loan, 23% of which from relative, 18% local moneylenders, 37% shopkeeper, 6.4% formal institution

Question 3

Governments have tried social lending programs, but have failed.

Give an example.

Answer 3

Burgess/Pande:
India 1977 - for every bank branch in the city, banks had to open 4 rural branches.

Failed as too many default rates, since social lending, rather than profit motives that would make them ensure they lend to people with good credit risk

Question 4

2nd stylised fact: Lending (borrowing) rates are much higher than deposit (saving) rates

What did Ananth find for borrowing rates for Indian vegetable vendors to be?

Answer 4

5-10% a day!!!!

5 x 1.05³⁶⁵ = £258m over a year!!!

Compared to savings rates barely 1%

Question 5

So if it is profitable to lend to the poor, why aren’t investors rushing to them with bags of money? (and competing down the interest rate?)

Answer 5

High capital costs for lenders

Repayment (done later) - links to asymettric info lenders face as a result to avoid repayment issues!

Question 6

Aleem findings on capital cost in Pakistan

Answer 6

Average interest is 78.5% , capital cost is 32.5%.

So explains some of the reason why there isn’t lots of lending, but not all of it. Repayment is another!

Question 7

3rd stylised facts: Extreme Variability of interest rates.

Aleema - What was the standard deviation of interest?

Answer 7

38.3%.

Which means 2% and 150% is possible in the same 95% confidence interval

Question 8

Ghate - interest in Thailand per month

Answer 8

2-3% per month Central Thailand

5-7% North

Question 9

Why are interest rates so variable?

Answer 9

To compensate for the risk of someone defaulting.

Higher default>higher interest rates.

Question 10

Stylised fact 4: Low levels of default

What are the repayment rates

Answer 10

98%.

Question 11

Das Gupta on default costs as a % of interest charges

Answer 11

Cost of defaulting explains 14% of interest charges.

Not a lot.

Question 12

Do despite high repayment, what is a caveat

Answer 12

It is often delayed, and/or requires hard work on lender’s part to chase. ISSUES WITH ASYMETTRIC INFORMATION TO PICK BORROWERS (ADVERSE AND MORAL HAZARD IN NEXT SUBTOPIC OF FCS!!)

Question 13

Stylised fact 5: Ex-Ante Competition in credit markets

Answer 13

Lots of moneylenders competing, IN TOWNS.

Since only go where expect to survive and profit, so concentrated heavily in those areas.

Question 14

Stylised facts 6: Borrowing to maintain business (not expand)

Given high interest, we would expect only to use if high returns were available otherwise not borrow.

Where are loans spent if not on expansion?

Answer 14

Most loans are taken to finance business stock, not expand.

Question 15

Timbers & Aiyar on where loans get spent

Answer 15

75% finances production or trade.

So if returns to regular business stock higher than interest rates (clearly since otherwise we wouldn’t use borrowing), why not save and use their own past income to finance stock rather than continually pay high interest?

Question 16

Stylised fact 7: Rich pay lower interest and borrow more

What did they find average interest to fall per month by, and upon what reason?

Answer 16

Average interest drops by 0.4% per month for each additional hectare of land owned by borrower (i.e richer as more land)

Question 17

Why do rich get lower interest rates

Answer 17

Collateral! So lenders willing to lend more, and at a lower rate since less of a risk.

So loan size increases with wealth, and then interest falls with loan size.

Question 18

Stylised fact 8: Common to borrow and save at same time

They would do this despite lending (cost of their borrowing) rate exceeding the saving rate
Why?

Answer 18

Baland & Mali - found some people take on loans as a way to pretend they are poor and cannot held friends in need/repay them.

Question 19

Vegetable vendors in Chennai - explain their daily process

Answer 19

Every morning buy vegetables on credit. (Loan 1000rs)

Pay off loan with daily revenue at end of day. (Pay back 10.50rs

Question 20

They are persistent borrowers, do this process on average 28 days a month.

What % feel there is no other way of doing business i.e interest is unavoidable

Answer 20

64%

Question 21

How much profit do they make

Answer 21

100 rupees

Question 22

How can they escape poverty?

Answer 22

Save, and then borrow the normal amount - amount saved!(Since no longer need to previous amount since saved on consumption)

Continue this until we borrow less and less

So you can save your way out poverty!

Question 23

Alternate method to escape poverty

Answer 23

Take a monthly loan opposed to daily loans

Question 24

Karlan ran experiments in India and Philippines where they paid off peoples debt.

What was their intuition they believed

Answer 24

The idea was that

No debt so could use revenues to buy tomorrows inventory, then use tomorrows to buy next days, etc never borrow again.

Question 25

Result

Answer 25

People went slowly back into debt (1-2 years)

So not easy to escape need for borrowing!

Question 26

What are payday loans

What is interest on US payday loans

Answer 26

If run out of money before payday, take this loan to tide over then pay it back on the payday.

Around 18% for 2 week loans!!! 7000% annually!! So quite exploitative for people who are in this position