We use cookies to give you the best experience possible. By continuing we’ll assume you’re on board with our cookie policy

Does group lending overcome cost constraints of lending to the poor Essay Sample

The whole doc is available only for registered users OPEN DOC

Get Full Essay

Get access to this section to get all help you need with your essay and educational issues.

Get Access

Does group lending overcome cost constraints of lending to the poor Essay Sample

Since the success of the Grameen bank in Bangladesh, group-lending micro-finance schemes have been seen by many as the most effective way of ensuring credit is available to the those who previously would not have had access to it due to the cost constraints they face when entering either formal or informal credit markets. Indeed, the UN proposed in 1997 that $21. 6 bn would be put invested in micro-finance schemes in order to reach some 100m of the worlds poor over the following 8 years (Wydick, 1999).

The purpose of this essay is to evaluate how effective at allocating credit to the poor group-lending schemes actually are. Firstly, however, a brief overview of credit markets will be given in order to look at the type of cost constraints the poor face when entering credit markets. Empirical evidence of various group-lending schemes will then be analysed in order to gauge how these schemes help the poor overcome the aforementioned constraints. Credit markets:

Many developing countries are characterized as having a high percentage of informal lenders in their capital markets. The main reason for this is that formal lenders (banks, govt backed institutions, etc) will not possess the necessary personal knowledge of their borrowers required to gauge how risky that borrower will be. They will only lend to those who can provide guarantees that they will not default, or that they can still repay the loan in the event of the investment that the loan was intended for failing.

These guarantees will typically take the form of collateral. Collateral can take many different forms, but the type of collateral that the poor have access to (if any at all) will typically take the form of land, labour, possible savings schemes intertwined with the lender, and even ration cards. As formal lenders will not accept these forms of collateral, the poor are priced out of the market.

It is worth noting however that the use of land as collateral may well enhance the already prevalent inequality of land distribution between the poor and the rich found in most developing countries, as it will be the poor who will lose their collateral (land) to the relatively rich (lenders) if they cannot repay a loan. Rural credit markets (and therefore informal lenders) also face these informational constraints as formal markets (although to a lesser degree); there may be little information as to what use the loan will be put to.

In addition, even if they do know what the desired use of the loan is, this will be extremely hard (and costly) to verify and they have no way of guaranteeing that the loan will be used in the most efficient manner possible. This may not be solely down to apathy on a borrowers behalf, but more likely that he doesn’t have the necessary education and experience to ensure that returns on the loan are maximised.

Binswanger (1986) stipulated that poorer, rural borrowers will carry a higher degree of risk due to risk of yield, price risk (prices often fluctuate greatly and so are difficult to predict), uncertainty of success due to the weather, breakdown risk of machinery and accident risk. Thus, the informal lender faces the problem of moral hazard. The lender will, in turn, incur monitoring costs associated with tracking the performance of loan. There is also the prevailing problem of adverse selection, where the lender does not know the likelihood of the interest, or in cases, the whole loan itself, being repaid.

The lender will therefore face screening and transaction costs associated with researching the credit history of a potential borrower. In rural areas these monitoring and screening costs will typically be high due to the cost of transport (personally going to the, possibly remote, village of the borrower in order to gauge his risk type and possible monitoring of a project) and the opportunity cost of time spent monitoring and screening. The lender will also face administration costs of providing the loan.

Even if these costs can be met, there is still an uncertainty about the reliability of the information received, which itself carries a cost in the form of increased risk for the lender. These costs may well be reflected by a higher equilibrium interest rate, which will in turn price the poor people out of the credit market. These effects were illustrated by a study by Ray in Chambar, Pakistan (Ray 1998) who found that the average interest rate charged in his sample of informal lenders was a high 78. 7%, mainly due to these costs. Group-lending:

Group-lending schemes help to counter-act some of these costs in the following manner. Instead of lending many small loans to different individuals, larger loans are lent to different groups of borrowers. Reducing the number of loans provided will in itself reduce the costs to the lender. These groups are normally put together on a self-selection basis, which often leads to groups of homogenous quality (although Zeller, 1998 argues, justifiably that groups will seek to diversify the employment within their members in order to lower the overall risk to the group).

Borrowers will also have a lot more information regarding the reputation, wealth and reliability of his/her fellow group members. This itself acts as a screening device as low risk borrowers will not want to risk their credit rating by grouping themselves with high risk types. If a borrow does default on his payment then he faces social sanctions imposed by the village. Apart from the unwanted humiliation that this may entail, he may lose certain village privileges, or, at worst, be expelled from the group and therefore not have access to credit.

This is by no means an idle threat, Bruce Wydick (1999) showed that a repayment rate for the FUNDAP group lending scheme in Guatemala of 97% was mainly a result of peer monitoring, ensuring that the perceived benefits of defaulting were vastly out-weighed by costs of doing so. Stiglitz (1990), Varian (1990) and Rashid & Townsend (1992) (all cited, Wydick “Can social cohesion be harnessed to repair market failures? , 1999) illustrate the benefits of peer monitoring as transferring the risk from lender to borrowing groups (less risk to the lender implies that he will be more willing to take on poorer, riskier borrowers), ensuring that group members can insure on another against any exogenous shocks, and the ability of group members to monitor each other, thereby minimising the moral hazard faced by the lender. Although not shown to be have a significant effect on repayment rates in Guatemala by Wydick, the mere presence of strong social ties with-in the group help reduce the risk of a member defaulting.

It should be noted, however, that groups of homogenous types would be less able to insure each other against exogenous shocks. Zeller (1998) noted that, in his research into group lending in Madagascar, that repayment rates were significantly lower for those groups whose risks were covariant. Due to relative lack of screening and monitoring costs and indeed risk faced by the lender, collateral is not a requirement for the groups to take on a loan.

This opens up the credit market to poorer individuals as, even if they could provide necessary collateral, they are more likely to be risk averse and so prefer to face a higher interest rate instead of providing collateral. As many informal lenders will not simply raise their interest rate (this will attract high risk types, whose expected gain from defaulting is independent of the interest rate), collateral is usually an obligatory requirement for an individual to receive a loan.

Furthermore, group-lending schemes are usually subsidized, and so charge an interest rate below the market equilibrium level. Ray (1998) calculated that, if the necessary (albeit reduced) screening, monitoring and administration costs faced by the Grameen bank in Bangladesh were implicitly included in the interest rate, it should be set to 32-45%. Instead it fluctuates at between 10-12%. Empirical Evidence: The Grameen bank (founded by Mohammad Yunus in 1983), widely seen as the model of micro-finance success in alleviating poverty, functions on those principles described above.

In this instance 90% of borrowers are women. The tendency for a whole group to default when one member defaults (in line with the view that the groups credit rating will be already damaged) is also reduced by the presence of sequential lending. The Grameen bank also provides a variety of social services to its members, and while there is no doubt that it has been successful in allowing the poor access to credit markets, this success is not always the case.

Zeller (1998) showed that in Madagascar no short-term loans (1-3 months) were provided by the different micro-finance enterprises. As these short-term loans would invariably been put to use as consumption credit by poor individuals (in order to cover an exogenous shock such as a fall in the price of the good they sell, death, illness, etc) this implicitly excludes the poorest individuals from the market.

Unfortunately, whilst it is relatively simple to track a program and obtain figures such as repayment rates over time, it is a lot more difficult to track where the loans are actually going, and indeed, whether they are going to the intended recipients – the very poor. Paul Mosely and David Hulme (“Microenterprise finance: Is there a conflict between growth and poverty alleviation? ” 1998) researched the effects of 13 different micro-finance schemes, including group- lending schemes such as BancoSol in Bolivia, BRI in Indonesia and the Grameen bank.

It found that the average increase in a borrowers income to be significantly lower for those borrowers already below the poverty line. For the BancoSol and BRI the difference was startling – increases of 270% and 540% for the whole sample compared to increases of just 101% and 112% respectively for those below the poverty line. There is no doubt that group-lending does allow the poor access to credit markets but the extent on that success also depends on the targeting of the program and the manner in which it is implemented.

This will vary from country to country, from village to village, so it is not sufficient just to take the model of the Grameen bank as a blueprint for success and apply it indiscriminately. Furthermore, there is a lack of research into how effectively group-lending schemes target the poor, indeed, that effectiveness itself is very hard to measure and so it is very hard to gauge how effective these programs are, especially as these figures can quite possibly be massaged by financial institutions or governments.

However, within the limited scope of this essay, I can conclude that group-lending does go some way to overcoming the cost constraints faced by the poor when entering credit markets, but the effectiveness will vary from scheme to scheme, and more research regarding this effectives should be undertaken before any definite conclusions can be made.

We can write a custom essay

According to Your Specific Requirements

Order an essay

You May Also Find These Documents Helpful

Peculiarities of various assignment types

The educational process is diverse and full of interesting writing tasks which help students develop their academic abilities. Different assignments types are created by professionals in order to enhance students’ level of analytical, critical and writing skills and to vary the learning process. As a student, you will encounter numerous tasks of diverse complexities throughout your student life. Sometimes, maybe, too complicated! They have different peculiarities, structural...

Making decisions in health and social care

Critically analyses the concepts, features, and importance of costs and accounting in making decisions in health and social care Cost accounting is a method used in accounting to capture a company’s or organisation’s production costs. It assesses the input costs of every step in production, fixed costs like depreciation of capital equipment. Cost accounting measures and records costs individually then compare the input results via...

Сhildren development

Physical development 7-12 years By the age of 7 a child enjoys things such as bike riding and rollerblading they are now able to tie and untie shoelaces without adult help, they are now starting to understand what rules are and are able to follow simple rules. At 8-12 years a child improves the physical skills that they have already developed and start to see...

Forex international trading market

Introduction Forex exchange is on the rise in Namibia; resulting in more people wanting to learn how to trade to try to increase their income so that they can enhance their standard of living. Forex Foreign exchange identifies the process of converting domestic currency into international banknotes at particular exchange rates (Bofah, 2017, para.1). As the number of foreigners in Namibia is increasing, more Namibians...

Aristotelian idea of God

This image produced in 1544 shows emerging's of the Judeo-Christians and Aristotelian's traditions. Aristotle was very interested in the idea of motion and said “The world is in a constant state of motion and change”. An example of how the world is changing is the growth of trees and plants. Aristotle believed in a prime mover, which is the being which creates change in the...

Get Access To The Full Essay
Materials Daily
100,000+ Subjects
2000+ Topics
Free Plagiarism
All Materials
are Cataloged Well

Sorry, but copying text is forbidden on this website. If you need this or any other sample, we can send it to you via email.

By clicking "SEND", you agree to our terms of service and privacy policy. We'll occasionally send you account related and promo emails.
Sorry, but only registered users have full access

How about getting this access

Become a member

Your Answer Is Very Helpful For Us
Thank You A Lot!


Emma Taylor


Hi there!
Would you like to get such a paper?
How about getting a customized one?

Couldn't Find What You Looking For?

Get access to our huge knowledge base which is continuously updated

Next Update Will Be About:
14 : 59 : 59
Become a Member