Question

The poor find it difficult to access the credit market. Discuss why, and make sure you touch on the following topics: asymmetric information, moral hazard, adverse selection, the lender’s problems, and how microfinance institutions are able to solve these. What does the recent evidence say about the impact of microfinance institutions on measures of household wellbeing?

Answer 1

It is true that poor people find it difficult to access the credit market due to various reasons.

Let us discuss the reasons why they find it difficult to access the credit market.

Following are the reaons:-

( I ) Asymmetric information:- It means the banks or the financial institutions are not able to find symmetric information ( or enough information to understand financial position of the borrower ) from the poor people. Borrower may be aware of his inability to pay back the loan amount given his source of income, still he may hide it from the banks or the borrowers leading to asymmetric information.

( II ) Moral Hazard - It exists when the borrower has an incentive to increase his exposure to risk such as default.

( III ) Adverse selection is also very similar to asymmetric information where banks may end up giving loans to the borrowers without true and complete information, leading to higher probability of default.

Micro - finance institutions use their robust and dedicated chain of workers who personally visit the residents of the borrowers to get complete information about the financial status of the individual, including his sources of income and ability to pay back the loan. Use of various machineries in times of default discourages borrowers from hiding their true financial situation.

Micro-finance institutions have greatly helped small businesses and borrowers who otherwise wouldn't have been able to borrow from the banks. Various governments across the world are now encouraging micro-finance institutions to help reduce poverty and encourage job creation by increasing credit support to the lower rungs of the society.