How Well Do Credit Markets Function in Developing Countries - Essay Example

How well do credit markets function in developing countries? The rates of interest are decided by the risk level determined by the finance institutions. In this case the main point is that the interest rate differentials are not reflective of the differences in the risks. They erode as time passes by. Moreover, if the levels of interest prevail, the credits and their availability is easier (Morduch 618). It has been argued that these rates of interests are subject to changes that occur in the supply and demand of the credits is meant for the creation of equilibrium. The interest rate differentials are persistent across many countries, many regions including the households. This persistency has not been justified by the lender’s hypothesis. The term used is the widespread rationing which refers to the fact that the investors and the creditors are not loaned in the ratios in which the loans are required. The formal credit has a link with the person’s wealth. The formal as well as the informal providers of the credit are inclusive of the local money lenders, landlords, the shopkeepers, relatives as well as the friends (Karlan 4). In the case of the informal credit markets, the borrowers have access to only a small number of credit markets as well as the finance institutions and money lenders. There are many arguments given, including the collateral being offered for the aim of securing the loans and it may be considered to be of higher values for the money lenders. Thereby, the lenders may be attempting to make the loans with the aim of acquisition of the assets that are often given as collateral (Townsend 67). These goals are achieved by setting the interest rates higher, thus leaving the borrower with lesser options but to be the defaulter. These reasons mark the inequalities in the land rates as well as the bonded labour as this has been especially noticed in the poorer countries and these regions have been known for uncertainties (Morduch 180). Microfinance, specially the ones used in the loans to be given out to the micro creditors, has been considered as collateral as well as costly and labour intensive. If the banks start to take interests on the microfinance, that is able to generate to the profits. The main need of the banks shall be the greater number of the micro creditors (Ray 23). The credit shall be given to these micro creditors according to the finances that are needed by them. The interest rates in the developed countries are higher as compared to the countries that are less rich. On an average, the banks have 900,000 clients for the micro credits and the target is to reach a million this year (Morduch 23). Profits generated by the banks can help the banks grow. Moreover, these profits can help in building stronger infrastructure of the microfinance industries. The more earning is made by the microcredit industry, the more is the attraction seen by the micro creditors as well as the investors and more is the investment made in the banks and the industry itself (Karlan 10). There have been arguments over microfinance and one of the main arguments says that the crediting from the poor people is unethical and wrong. It has been considered as wrong when the lending is the main activity considered as predatory. The term predatory lending refers to the fact that the borrower is unable to pay the interest set by the banks and the other financial institutions. Moreover, it has been argued that these are the cases when poorer people are considered to be unable to pay the principle associated with credit. In case of many banks, it has been argued that the benefits such as the income benefits have to be taken into account by the poor people (Mookerjee 225). These schemes give lower default rates and higher rates of income satisfaction. Transparency on the interest rates has been offered by the banks so the ignorance from the borrowers is reduced, providing them the required level of satisfaction. The information asymmetries play an important role in the researches been carried out in the field of micro credit. These are difficult to identify in the theories but are more apparent in the case of reality. Hidden information and hidden actions are the main issues to be dealt in the micro credit markets. The information asymmetries have affected the economic policies and the lending behaviours throughout the world. Thereby, the slower flow of the information and the credit market failures are some of the main facts that have to be kept in mind as these can create inefficiencies at a global level. A research has been conducted on the South African finance company based on the asymmetries in the information. This finance company has been known to lend 200% APR. The interest rates had been randomized in three dimensions inclusive of the interest rates that are offered to the customers through mails, the actual interest rates on the loan contracts, as well as the interest rates that are offered on future loans (Bowles 300). Figure: Micro crediting: Global Trend Hidden information in this research has been defined as the selection effects that include the selection made on the unobserved risk type, which in other words is known as the classic adverse selection. This type also includes the selection made on the anticipated effort that has been considered to be unobserved. Hidden actions have been referred to as the ex post incentive efforts. Distinguishing between the hidden actions from the hidden information has been thought to be critical in the case of the policy and the practical perspective (Bell 2389). By the help of this research, it has been seen that there is weak evidence regarding the hidden information usage in the case of South African company. It has been seen that the information symmetries are important for the credit market interventions (Townsend 360). These interventions are presupposing the fact that the rationing in the credit market arises as a result of the asymmetric information problems. Business and finance policies are to be designed and crafted to make sure that these information asymmetries are removed in order to answer three main questions. The first question deals with the kinds of the information asymmetries that are designing and shaping the credit markets. Lending practices and what their relative kinds are effective in the case of the mitigation of the information asymmetries. It has been argued that there is a need of the study of marginal borrowers as these borrowers have been the focus of many credit market interventions. Also, these borrowers can pose threats to the information flow (Basu 294). Microfinance has been known as one of the main ways that can help the poor people in dealing with their poverty. Micro financing in the credit markets has been on a great rise in the countries as Mexico as well. However, the importance of credit has to be highlighted. Credit is the need in these days as there are three main sources for credit demands and these are inclusive of the investments that are to be made in the fixed capital, as there is a large need of the working capital as well as the consumption smoothing. In the light of the researches, it has been seen that in the older days the people had to buy homes and cars in addition to the various necessities in their lives, education had been a requirement as well. These are all the necessities that were bought as the investors had access to long term credits being offered by the banks. These long term credits were also being offered to the poor people in the areas so their lives could be improved. Credit markets, in addition to functioning for the poorer people, can also function an improvement in the economic situation in the country (Bowles 304). Figure: Micro crediting in different countries Another country that has to be taken into account is Ghana. In this case, the sources of finances include banks, trade credits, suppliers, clients as well as family and friends. There are many other countries whose data has to be included such as China, Pakistan, India, Korea as well as the rich countries as Malaysia. In India there is a great change in the policy implications that can lead to the betterment of credit markets. One of the policy changes have been implicated by the use of the regional rural banks and these are often referred to as RRBs. However, as time passed by there were many problems noticed in this case and these included higher failure rates associated with the reaching of the poorer population in the country, the higher rates of the defaulters as they make the policy implementations harder as well as expensive, and the adverse effects that have been noticed on the informal sector in the credit market. Thereby there is a need of a set of the policies that can help in the improvement of credit provision in which the provision takes place by the help of the government involving the informal institutions (Bell 2390). Figure: Micro crediting in India More over, the micro finance institutions in India have the access to capital as it can help them in their sufficient growth in the credit market. There were some MFIs who chose to slow down their growth in order to see the conditions in the changing credit markets. Valuations in the case of the micro finance institutions are carried out and the small micro finance institutions are hit harder. This is because the equity has been becoming expensive with the changes in the financial markets. One of the other main changes that has been noticed in the Indian capital markets is the drying of the donor capital market of the non profit MFIs. As compared to the non profit MFIs, the Profit MFIs are seen to be more successful, whereas the non profit MFIs are looking for the donor capital for their growth. This has been seen as a major problem as there is a standard required for the non profit MFIs in order to make sure that they keep on providing the credits in the future to their customers. However, the microfinance in India is expanding in spite of the fact that the micro finance market in the world is facing many issues (Bowles 307). Conclusion There are many countries in which the citizen sector, where the needs in accordance to the microfinance sector, is not connected to the needs of the global finical markets. Thereby these sectors are seen to be less effected by the macro issues in the financial markets. The main change is needed in case of the lending and the related behaviours in the financial markets, thus keeping the repayment issues to a minimum so the micro credits are continuously provided to the poor people in the rural areas who are in need of it the most. Works cited Bibliography Basu, K. Analytical Development Economics. MIT Press, London, 1997. Bell, C. Credit markets and interlinked transactions in Chenery and Srinivisan (eds), Handbook of Development Economics Vol 1. Elsevier, 1988. Bowles, S. Microeconomics: Behaviour, Institutions and Evolution. Princeton University Press, 2009. Mookerjee, D., and Ray, D. Readings in the Theory of Economic Development. Oxford, Blackwell Publishers, 2001. Morduch, J. and D. Karlan. “Access to Finance,” Handbook of Development Economics, Volume 5. Amsterdam: Elsevier. Forthcoming 2009. http://karlan.yale.edu/p/mfgames_1may09.pdf Ray, D. Development Economics. Oxford University Press, 1998. Townsend, R. Credit, intermediation, and poverty reduction in Banerjee et al. Understanding Poverty, Oxford University Press US, 2006. Journal articles Karlan D., J. Zinman. Observing Unobservables: Identifying Information Asymmetrieswith a Consumer Credit Field Experiment, Econometrica, forthcoming 2009. http://karlan.yale.edu/p/OU_dec08_v1.pdf Morduch, J., Cull, R. and D. Asli. “Microfinance Meets the Market”. Journal of Economic Perspectives 23 (2009): 167-192. Morduch, Jonathan. “The Microfinance Schism”. World Development 28 (2000): 617-629. Read More