Question

write an essay on formal and informal credit markets in Kenya

Answer 1

It is claimed that financial markets in Africa are rather fragmented, creating formal & informal arrangements.

Whilst formal financial establishments are controlled by the CMA, informal financial establishments are outside the CMA’s supervisory control.

IFMs comprise of Shylocks, pawn brokers, traders etc.

Formal and informal financial institutions serve various clientele with no links amongst the clientele served. It is thus not clear whether the prevalence of IFMs presents an issue or a solution to the fragmentation of the financial markets in Africa.

Historically, fund lenders were considered parasites who exploited poor peasants because of the high interest they charged.

But how many can avail funding from banks? Currently, informal lenders give effectual financial services to a huge clientele which is ignored by the formal sector. In several developing nations, the informal sector constitute 60% of total lending.

Despite the role played by IFMs, few studies claim that easing restrictive policies can enlarge the formal sector leading to the eradication of informal lending. This claim isn’t in touch with grassroots actuality.

Financial dealings involve the exchange of funds in the present for a promise of future payment. But, most lenders lack the capability to ascertain whether a borrower will really pay.

This issue is due to info asymmetry, moral hazards & adverse selection in credit markets.

Info asymmetry happens where one of the sides to a financial dealing has more info than the other.

Adverse selection happens when there is a lack of symmetric info prior to a transaction between the borrower & the lender.

On the other hand, moral hazard happens when there is asymmetric info between the 2 parties & behavioural change of one side (mostly, the borrower) after the lending deal has been concluded.

As demand for loans exceeds loan supply, moral hazard augment causing lenders to employ non-price rationing instead of increase interest rates.

Info asymmetry is prevalent in low-income nations where info flow is restricted and financial info is lacking or expensive to obtain.

Information collection expenses for big financial institutions keep increasing causing lenders to turn away from the market. This creates prospects for informal financiers who can simply gather info at low cost utilizing local networks.