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The reasons behind the failure of traditional development banks, focusing on informational disadvantages and the institutional approach to policy. The challenges of rationing credit, enforcing repayment, and maintaining financial viability. It also introduces the concept of microfinance and the grameen bank as a solution, highlighting the benefits of group lending and frequent repayments.
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Informational Disadvantages ,! adverse selection ) ration credit or make a loss
Inability to Enforce Repayment ,! insu¢ cient sanctions to ensure repayment ,! political expediency
Lack of Financial Viability ,! interest rate restrictions ,! easier to secure central bank funds than attract deposits
Must design institutions that can compete with informal money lenders Vertical formalñinformal linkages: use moneylenders as agents ,! takes advantage of their information ,! potential for collusion amongst agents ,! perverse impacts under monopolistic competition
Engage in related business (tradeñcredit interlinkage) ,! e.g. PhilippinesíNational Agricultural Productivity Program (Ray, p.
Grameen Bank started by Mohammed Yunus (1976) with help from Bangladesh Bank
Later helped by IFAD, Ford Foundation and several governments
Use group lending and peer monitoring
Programs now exist worldwide ,! well-established programs in Bangladesh, Bolivia and Indonesia ,! new programs in Mexico, China and India ,! villages along the Amazon ,! inner-city Los Angeles, Toronto and Halifax
Grameen I ("classic")
Groups of 5 formed voluntarily ,! encourages ìassortative matchingî
No collateral required
2:2:1 staggering ,! individual loans made Örst to 2, then 2 more, then the Öfth at 4- week intervals ,! cycle continues as long as loans are repaid
Success traditionally attributed to role of "joint liability"
More recent analysis emphasizes other aspects ,! dynamic incentives ,! high frequency repayment schedule ,! 95% female borrowers ,! current movement towards individual lending (Grameen II)
Example: 2 member group One-period project requiring $1 investment Bankís cost of $1 loan = k Fraction q of borrowers are "safe": gross return = y The remaining 1 q are "risky":
Gross return =
y¯ with prob. p 0 with prob. 1 p
Identical expected return: p y¯ = y Borrowers know each others types, but lender doesnít Assortative matching ) a fraction q of groups are (safe, safe)
