The Design of Micro Credit Contracts and Persistent Access to Credit Constraints of Micro Enterprises in Uganda

Abstract

Contractual arrangements in microfinance are designed to overcome the problems of adverse selection and moral hazard that are prevalent in developing and low income countries. Micro credit lenders use “innovative” lending methods such as group lending, contingent credit and use of collateral substitutes to provide credit to those unable to borrow from mainstream financial institutions such commercial banks. However, despite growth of the microfinance industry in terms of outreach and product development, the businesses at the bottom end - micro enterprises - still face considerable access to credit constraints. A study of micro enterprise access to credit in Uganda revealed limiting factors such as the evolving nature of micro credit and its providers, the lack of flexibility in structuring micro loans, and the negative perceptions about loan application and screening processes. In addition, harsh expected consequences of default, the disincentives of contingent credit, and the blind sanctioning of default also negatively impact access to credit. The study involved 602 micro enterprises located in various parts of Uganda and 105 lending institutions including commercial banks, credit institutions, microfinance deposit taking institutions, microfinance non-deposit taking institutions and Savings and Credit Cooperatives and Savings and Credit Societies.