Informal Lenders Research Articles

Microfinance for poverty alleviation: Do transnational initiatives overlook fundamental questions of competition and intermediation?

Numerous microfinance initiatives around the world aim to alleviate poverty in developing countries. However, debate persists about their effectiveness and sustainability – a concern for transnational corporations and the international business community, which contribute about $9.4 billion to microfinance funding. In this policy-oriented article we aggregate findings from two studies in Indonesia that help explain why moneylending can still thrive when low-interest microfinance is widely available and why the poorest borrowers benefit less than the less-poor. To avoid methodological debates about validity, we interview market participants and triangulate the perspectives of borrowers with those of formal and informal lenders. Importantly, our research includes current and past borrowing from formal and informal sources, prompting participants to draw comparisons. We find that the importance to borrowers of key characteristics of informal lending is insufficiently recognized and that inappropriate human resource management and informal intermediation are significant problems. The latter can be an unintended consequence of formal microfinance: The availability of formal low-interest microfinance creates informal intermediation opportunities for entrepreneurs, often developing from casual intermediation into systematic deception. We discuss implications for microfinance policy with reference to the United Nations Sustainable Development Goals and offer suggestions for further research.

Informal Lending and Entrepreneurship

How does the informal economy affect financial inclusion and entrepreneurial activity of consumers? We investigate the impact of informal lending on the types and terms of contracts offered by formal lenders, considering factors that facilitate informal lending activity such as social ties between consumers. The density of the connections between consumers represents the degree to which those with and without wealth mix, indirectly capturing the degree of inequality in a society. We develop a model which relates the density of social connections to the availability of informal lending activity. We show that a low to moderate degree of informal activity in a market can help unwealthy entrepreneurs because it motivates the bank to compete by cutting down the interest rate of unsecured loans offered to these consumers. In turn, the bank faces an overinvestment problem when financial inclusion is higher. As informal borrowing opportunities increase further, lenders’ benefit from increased access to credit diminishes. It earns higher rents by increasing the rates on wealthy low-risk consumers who can informally lend to their social contacts. As a consequence, the overinvestment problem is replaced by an underinvestment problem and creditworthy entrepreneurs are deprived of loans from banks. We argue that although the entrepreneurial investment shrinks, only those projects with the best return are awarded financing, implying that the average investment in the market is now more attractive.

Informal Lending in Emerging Markets

Microentrepreneurs in emerging markets often rely on informal lenders for their routine borrowing needs. This paper investigates informal lenders’ and microentrepreneurs’ incentives to participate in a lender–borrower relationship in a market in which repayments are neither law protected nor asset secured. We consider a borrower who seeks a short-term loan, invests in a project, and repays in full using her project earnings if the project is successful. If the project fails, the borrower uses her outside option to repay over a period of time. The analysis uncovers an interesting effect of the borrower’s outside option on the loan rate offered by the lender—the loan rate first increases and then decreases with the borrower’s outside option. An important policy implication is that an increase in the outside options of the poor microentrepreneurs might actually reduce their surplus. Finally, we find that lenders in emerging markets may be more likely to engage in informal lending compared to those in developed or poorer markets.

Direct and Spillover Effects of Targeted Cash Transfers on Ethnic Rural-Urban Migration in China

This paper relies on recent proprietary data from China’s poor rural minority areas to examine the importance of credit constraints on rural-urban labor migration. Specifically, a liquidity shock via China’s minimum living security allowance (MLSA) program is decomposed into its direct and indirect parts. The institutional features of the MLSA program permit an identification strategy that relies on a set of verifiable assumptions and an instrument variable (IV) framework. The results reveal that the direct effect on migration of MLSA is negative, although the net effect is positive driven by the large indirect effects, which are twice as large for ethnic minorities compared to the Han majority. Subsequent evidence further suggests that the main mechanism behind the indirect effect is informal inter-personal lending fostered by risk-sharing strategies. The findings imply that once liquidity is injected into a village it gets circulated in the community, stimulating migration particularly within credit constrained minority communities.

Loan repayment performance of clients of informal lending institutions

PurposeThe purpose of this article is to examine the effects that dynamic incentives and the borrowing histories of clients of informal lending institutions have on loan repayment performance, in particular, the extent to which multiple borrowing and progressive lending affect the repayment of loans.Design/methodology/approachThe paper uses a data set of 835 borrowers drawn from an informal lending institution in Tanzania. Descriptive analysis and econometric models are used to test the developed hypotheses.FindingsWhereas clients with multiple loans are associated with poor loan repayment, progressive lending contributes to positive repayment outcomes. Multiple borrowers face increased debt levels and thereby an increased inability to meet their repayment obligations; in contrast, progressive lending by building up a lender–client relationship helps clients to obtain higher loans with a minimum amount of screening.Research limitations/implicationsThis was a cross-sectional study based on a sample of individual clients drawn from a single institution. However, since the majority of clients had also taken out loans with other financial institutions, the sample is considered to be representative.Practical implicationsA client’s past repayment performance and multiple loan history must be assessed so that multiple borrowing can be prevented and credit absorption capacity can be gauged more accurately. The repeated nature of the interactions and the threat to cut off any future lending (if loans are not repaid) can be exploited to overcome any information deficit.Originality/valueThis study was conducted in a context in which the degree of information sharing was low and institutional access to clients’ credit histories was limited. It contributes knowledge on how lenders minimise the risk flowing from the ex ante information gap and moral hazards arising from the ex post information gap.

Six myths of farmer finance

This article revisits some of the most often held assumptions around smallholder finance, and presents field experiences and research challenging these ‘myths’ around supply and demand of agri-finance. On the credit supply side, the article finds that smallholders do not necessarily lack access to ‘finance’, but do not use formal bank loans much and rely more on informal lending. It argues that the characterization of informal moneylenders as usurious is overly simplistic, and sees clear market mechanisms at play in informal lending. The article also presents evidence that the agri sector is riskier than others sectors. On the demand side, evidence suggests that farmers do not always want to apply fertilizer to their farms, or even take out a loan if it were available. Finally, the opinion that farmers deserve a fair (low) interest rate is investigated. In conclusion, the article provides recommendations to policymakers and project designers about approaching agri-finance as a new product in an existing market, and checking assumptions about demand at each stage.

Credit Market Structure and Collateral in Rural Thailand

This paper empirically examines reliance on collateral in different credit market segments—formal, semiformal and informal lending—of a developing rural financial market. Determinants of collateralization indicate that all three types of lenders price risk conventionally. Controlled for standard risk factors, however, formal lenders rely on collateral about 40 per cent more often than informal lenders. The difference is explained by informal lenders’ better information on borrowers. This is shown by informal lenders’ behaviour: a longer lending relationship does not improve information about the borrower but shorter distance to the borrower does—the opposite applies to formal lenders, as predicted by theory.

DO MICROENTERPRISES’ SIZE AND STATUS MATTER TO ACCESS INFORMAL FINANCE?

Formal microenterprises (MEs) when cannot obtain the resources they need through the formal financial sector may resort to other informal intermediaries. In this paper we analyze whether MEs, according to their size and registration, rely on informal financial lenders. Through a sample of 400 MEs drawn in the city of Puebla (Mexico) during 2006, we found that both informal and formal MEs resort to informal finance but, although MEs’ status matters per-se, informal middle sized MEs rely on moneylenders as well as on loans from family and friends. As formal MEs, no matter their size, seek for funding in the fringe financial market too, the results suggest that credit for MEs is scarce.

Rethinking the Effects of Microcredit on Household Welfare in Cambodia

This article analyses the effects of microcredit on household welfare in terms of household expenditure per capita in Cambodia, with data from the Cambodia Socio-Economic Survey carried out in 2014. The analysis describes the effects via formal and informal lending sectors, accounting for endogenous selection bias arising from unobserved factors and for structural differences between borrowers and non-borrowers in terms of expenditure functions. The findings suggest that microcredit in both sectors reduces household expenditure.

Informal Lending in Emerging Markets

Micro-entrepreneurs in emerging markets often rely on informal lenders for their routine borrowing needs. This paper investigates micro-entrepreneurs’ and informal lenders’ incentives to participate in a lender-borrower relationship in a market in which repayments are neither law-protected nor asset-secured. We consider a borrower who seeks a short-term loan, invests in a project, and repays in full using her project earnings if the project is successful. If the project fails, the borrower uses her outside option to repay over a period of time. The analysis uncovers an interesting effect of the borrower’s outside option on the loan rate offered by the lender - the loan rate first increases and then decreases with the borrower’s outside option. An important policy implication is that an increase in the outside option of the poor micro-entrepreneurs might actually reduce their surplus. Finally, we find that lenders in emerging markets may be more likely to engage in informal lending compared to those in developed or poorer markets.

Covariate and Idiosyncratic Shocks and Coping Strategies for Poor and Non-poor Rural Households in India

The objective of the paper is to track the association between different type of shocks experienced by rural households and corresponding coping strategies opted by them as they are, not only exposed to household-level and community level shocks, but also, lack effective risk management strategies which make them vulnerable to get into chronic poverty. A probit analysis has been used to articulate the comparative static distinction of risk management strategies between poor and non poor rural households using Additional Rural Incomes Survey/Rural Economic and Demographic Survey (ARIS/REDS) data surveyed by National Council of Applied Economic Research (NCAER) in rural India across 17 states to get a comparative static analysis. Households, generally, withdraw savings, seek remittances from migrant family members, take loan from formal and informal lenders and sell their existing assets and participate in Government sponsored welfare based programs to control after effect of shocks. Comparatively non-poor rural households could build up safety net (precautionary measure) to cope with price rise and other sudden shocks. But, extremely poor, generally, if don’t get help from relatives or can’t borrow from informal sources, ultimately starve at the time of sudden shocks. The welfare based government programs fail to arrest this extreme situation of grief during the idiosyncratic shocks.

Desarrollo local y microfinanzas como estrategias de atención a las necesidades sociales: un acercamiento teórico conceptual

Poverty as a public issue encourages further thinking about the responsibility that the State has towards its citizens. This article aims to explore the different theoretical approaches to the notions of local development and microfinance, to establish them as tools to deal with the socioeconomic needs of underprivileged people. In this sense, the hypothesis of this paper considers that local development and microfinance are indeed essential tools to solve social needs, as a source of poverty. In fact, apart from the official banks and informal lenders, microfinance institutions have revolutionized the financing of economic and social development, especially in Asia, Africa and Latin America. Through an analytical review of literature we conclude that rationalization of microfinance is a crucial operational and conceptual stage that must transcend the goal of supporting local development and tackling poverty, as it is the outcome of a complex decision-making process with multidimensional impacts.

Bpi Globe Banko and Inclusive Banking in the Philippines

In early 2014, John Rubio became CEO of BPI Globe BanKO, the three-year-old mobile-based savings bank that was far from accomplishing its mission to bring banking to the majority of Filipinos who did not have access to basic financial services, and to do so profitably. Rubio formulated a three-pillar strategy to increase customer acquisition and financial product offerings. His goals were to reach 1 million customers by year-end 2014 and supplant high-cost informal lenders. There was enormous potential but limited time, and Rubio needed to make a decision. Which of the current initiatives would lead to sustainable profitability and the ultimate goal of providing banking services to the masses? Excerpt UVA-GEM-0137 Oct. 30, 2015 BPI Globe BanKO and Inclusive Banking in the Philippines In mid-2014, John Rubio, the CEO of BPI Globe BanKO, had many things on his mind. Most had to do with problems in the Philippines that, in his opinion, needed to be addressed; they included issues in education (“So many brilliant people in the Philippines have to drop out of high school after their second year so they can work on the farm”), health care delivery (which was constrained), and housing (the country faced a 4-to-5-million-unit housing deficit in the next three years). But the critical challenge for Rubio was how to help reduce the country's high poverty rate by bringing financial services to every Filipino. In a country in which only one in four households had access to banking services, it was clear that much was still to be done. Time was not on Rubio's side. The company he took over in late 2013 was incurring sizable losses from legacy operations. Given no more than three years to turn things around, he needed to make swift decisions on strategies that could ultimately lead to sustainable profitability and help move the country toward an inclusive financial system. The Philippine Economy and Banking . . .

Can the availability of informal loans be detrimental to microloan repayment?: Some empirical evidence from Bangladesh

Prior to the introduction of microcredit system, informal loans were the major sources of credit for the poor. Even after the introduction of microfinance institutions, informal loans have been playing a significant role in credit market for the poor in developing countries. Household level micro data from Bangladesh shows that currently the major sources of informal credit are relatives, neighbors, and Mahajans, who are non-institutional professional money lenders. Mahajans are much more powerful in the society than the poor borrowers. While interest rates are relatively low for loans from relatives and neighbors, they are much higher for loans from Mahajans. This study explores whether or not the availability of informal loans has any effect on the repayment of microloans. In order to test the impact of multiple informal loans on the microloan repayment by a client, this study uses household level micro data from Bangladesh. The data shows that about twenty percent of the micro-borrowers borrowed at least once from the relatives and about thirty percent of the micro-borrowers borrowed at least once from the neighbors. This study uses gender, age, and education of the borrowers along with reasons for borrowing as control variables. By using an ordered logit model, this study finds that a micro-borrower’s access to low-interest informal loans, such as loans from relatives or neighbors, does not significantly deter them from repaying microloan. Taking high-interest informal loans such as the Mahajan loan, which may be indicative of financial trouble of the micro-borrower, however, lowers the probability of microloan repayment. This study finds that giving further microloan during the financial trouble of a microborrower can increase the probability of loan repayment. This study also finds that the probability of microloan repayment is higher for women, more educated individuals, relatively older people, and for borrowers with small amount of loans. These are significant findings, because loan recovery is important for the sustainability of microfinance institutions. In future, if the informal loans become almost non-existent, which is unlikely in Bangladesh context, the microfinance institutions will have to be less concerned about the impact of informal loans on them as the number of such borrowers will be very small. Until then, the findings of this study will remain significant for Bangladesh. Furthermore, the conclusions based on this data may be applicable to many other countries with similar institutional environment. This paper may help microfinance institutions in designing the optimal microloan contracts and improving loan recovery rates by taking into account the role of various types of informal lenders that exist in all developing countries.

The Impact of Microfinance Institutions on the Informal Credit Market: Evidence from Andhra Pradesh

This paper explores the reaction of informal lenders to the expansion of microfinance institutions (MFIs) in the rural credit market of Andhra Pradesh. Using an IV strategy to deal with endogeneity concerns, we document that an increase in MFI loans significantly raises the informal interest rate. Yet, we show that the effect of MFI expansion on the informal interest rate differs across villages according to the level of competition in the informal credit market, as measured by the landless share in the village. In particular, we find that the impact of microcredit supply is positive and significant in villages with low level of competition, but not significant in villages with high level of competition. We argue that in less competitive villages, increasing MFI loans generate detrimental consequences for the poorest, by worsening their informal credit market access conditions, while in more competitive villages, MFIs cannot subtract clients from moneylenders.

Taking Part: The Social Experience of Informal Finance in Ordos, Inner Mongolia

This article examines how a resource bonanza in Ordos Municipality, Inner Mongolia Autonomous Region, in the 2000s translated into broad-based participation in informal lending networks and drove a remarkable, but short-lived, phase of urban expansion and private wealth accumulation. Local lending networks inflated enormous credit and property bubbles, which ultimately burst in 2011 with severe ramifications for Ordos's urban expansion and households' livelihoods. Based on fifteen months of ethnographic fieldwork in Ordos, the analysis advances the idea of “taking part” to explore the interconnected desires to participate in urban expansion and to seize for oneself a portion of the local bonanzas in natural resources, property, and finance. The socio-spatial impacts of the financialization of the everyday environment are discussed in relation to urban transformation, the production of a “ghost town,” and local authorities' opportunistic forms of deregulation. These were vital ingredients in Ordos's spectacular passage from boom to bust.

Unfulfilled loan demand among agro SMEs in Namibia

Using a qualitative methodology approach, a case study research design by way of in-depth semi-structured interview(s) was followed to interview farmers, commercial banks, development banks, venture capitals and private equities to determine the financing options available for farmers and provide reasons why some financial institutions shy away from providing finance to agricultural enterprises. This study deviates from prior studies which have focused on small-scale farmers and subjected farmers’ access to finance to rural credit markets, mostly informal money lenders using secondary information mostly from household surveys to build econometric models. The study indicates that only about 33 percent of formal financial institutions are providing finance to agricultural SMEs. The lack of expertise and perception of risk were cited as top reasons why formal financial institutions find it hard to provide finance to agricultural SMEs. Building on opinions from other authors cited in this paper, we maintain that new financing mechanisms can be achieved by all types of financial institutions through learning from experiences by other successful countries.

Effects Of Collateral On Loan Repayment: Evidence From An Informal Lending Institution

ABSTRACTWe examine the effect of the collateral informal lenders use to ensure loan repayment. Specifically we measure how the use of movable and immovable assets affects loan repayment and delinquency rate, and assess the extent to which guarantorship and relationship-lending act as collateral to improve loan repayment. With a dataset of 835 individual borrowers drawn from an informal Tanzanian lending institution, we run descriptive and econometric models. The results suggest that movable assets increase the likelihood that borrowers perceived to be less creditworthy will obtain loans from informal sources and repay them. We also find a small proportion of customers to have pledged immovable assets as collateral when borrowing from informal lenders. The results also show the positive effect of referral, which implies that relationship lending and social collateral is key to increasing access to finance through informal lenders. Our results contribute to the advancement of economic theory, specifically in the ex-ante and ex-post-related literature.

Microfinance and Moneylenders: Long-Run Effects of MFIs on Informal Credit Market in Bangladesh

Using two surveys from Bangladesh, this paper provides evidence on the effects of microfinance competition on village moneylender interest rates and households’ dependence on informal credit. The views among practitioners diverge sharply: proponents claim that MFI competition reduces both the moneylender interest rate and households’ reliance on informal credit, while critics argue the opposite. Taking advantage of recent econometric approaches that address selection on unobservables without imposing standard exclusion restrictions, we find that the MFI competition does not reduce moneylender interest rates, thus partially repudiating the proponents. The effects are heterogeneous; there is no perceptible effect at low levels of MFI coverage, but when MFI coverage is high enough, the moneylender interest rate increases significantly. In contrast, households’ dependence on informal credit tends to go down after becoming MFI member, which contradicts part of the critic’s argument. The evidence is consistent with a model where either MFIs or moneylenders engage in cream skimming, and fixed costs are important in informal lending.

Alternative ways of managing supply side in microfinance: Study of rrbs, Cooperative societies, Chit Funds and informal lenders

Ideation of Microfinance happened when formal finance failed to make a dent inpoverty. But this self-proclaimed panacea for poverty, ‗microfinance‘, has also failed in manyinstances questioning the feasibility of microfinance institutions. Though microfinance is a recentphenomenon in India, there have been many institutions created with the mission of helping poor andalleviating poverty. We look at some of these institutional mechanisms like cooperative societies andRegional Rural Banks that Indian government tried for poverty reduction. Decades of these effortson poverty reduction has not succeeded well, and informal finance still exists and continues as amajor source of support for poor. We would closely look at the aspects which can be adopted widely,hence helping the overall poverty reduction efforts.