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Are Banks Responsive to Credit Demand Shocks in Rural Economies?

Sankar De's picture

How effectively does the commercial banking system respond to idiosyncratic shocks to the income and consumption of the households in the rural sector of an economy, and does it make extra credit available at a reasonable cost? This is an enormously important question. Farming operations in emerging economies are still heavily dependent on rainfall. Intermittent failure of monsoons and other weather-related vicissitudes often upset the normal income and consumption patterns of many rural households. However, a survey of the literature on rural financial markets finds few studies on the responsiveness of the financial intermediation system to credit demand shocks.

By contrast, local bilateral credit and insurance arrangements with landlords, moneylenders, family and friends, or group-based mutual savings and insurance arrangements such as rotating savings and credit associations (ROSCAs) have received much attention in the literature (see, for example, Coate and Ravallion 1993; La Ferrara 2003; Townsend 1995; Genicot and Ray 2002). However, the risks to income and consumption that rural households face are typically correlated, as they arise from common external shocks such as floods and famines, and the pool of savings is usually limited. As a result, local markets fail to offer adequate diversification opportunities and funds at a reasonable cost. Consequently, individuals and households in the rural economy are left facing considerable residual risk, with no option but to adopt costly and inefficient strategies to smooth income or consumption. A number of such strategies have been discussed in the existing literature, including scattering plots of cultivable land (McCloskey 1976; Townsend 1993) and  opting for a more diversified mix of crops and nonfarm production activities at the price of a lower average return, adjustment of inter-temporal labor supply in response to shocks (Kochar 1999), labor bonding (Srinivasan 1989; Genicot 2002), selling investment assets to smooth consumption (Rosenzweig and Wolpin 1993) and several other options. Not surprisingly, the welfare implications of the strategies are typically very negative.

Does the introduction of movable collateral registries increase firms’ access to finance?

Maria Soledad Martinez Peria's picture

To reduce asymmetric information problems associated with extending credit and increase the chances of loan repayment, banks typically require collateral from their borrowers. 

Movable assets often account for most of the capital stock of private firms and comprise an especially large share for micro, small, and medium-size enterprises. Hence, movable assets are the main type of collateral that firms, especially those in developing countries, can pledge to obtain bank financing. While a sound legal and regulatory framework is essential to allow movable assets to be used as collateral, without a well-functioning registry for movable assets, even the best secured transactions laws could be ineffective or even useless.

Given the importance of collateral registries for moveable assets, 18 countries have established such registries in the past decade. However, to my knowledge there is no systematic empirical evidence on whether such reforms have been effective in fulfilling their primary goal: improving firms’ access to bank finance.

More and better financial tools, fewer financial crises: The role of the financial system in managing risk

Martin Melecky's picture

Only by providing useful risk-managing tools and keeping its house in order, can the financial system fulfill its socially beneficial risk management function. Through the provision of useful financial tools, the financial system can shield people from bad shocks, and better position them to pursue opportunities. However, if the financial system fails to manage the risk it retains, it can also hurt people directly by hindering access to finance or indirectly by hampering refinancing of enterprises and straining public finances, and thus make people lose jobs, income, or wealth.

Public policy can stimulate the financial system to broaden the share of people with access to financial services (financial inclusion), so more people have more and better financial risk management tools. It can also promote measures to better control the risk that affects the whole financial system and foster financial stability. However to succeed on both fronts, the World Development Report 2014, in its chapter on the financial system, argues that public policy must take into account the trade-offs and synergies in the financial sector. The first step to balanced and successful policies is to establish an institutional framework that brings together policymakers and experts from the financial industry and academia.

I elaborate on this idea in subsequent paragraphs and encourage interested readers to pick up WDR 2014, in particular its chapter on the financial system, to learn more about the background and justifications for this proposal.

Finance and Poverty: Evidence from India

Thorsten Beck's picture

The relationship between finance, inequality and poverty is a controversial one. While some observers attribute not only the crisis but also rising inequality in many Western countries to the rise of the financial system (e.g. Krugman, 2009), others see an important role of the financial sector on the poverty alleviation agenda (World Bank, 2008). But financial sector policies are not only controversial on the macro, but also micro-level. While increasing access to credit services through microfinance had for a long time a positive connotation, this has also been questioned after recent events in Andhra Pradesh, with critics charging that excessive interest rates hold the poor back in poverty. In recent work with Meghana Ayyagari and Mohammad Hoseini, we find strong evidence for financial sector deepening having contributed to the reduction of rural poverty rates across India by enabling more entrepreneurship in the rural areas and by enticing inter-state migration into the tertiary sector.

Mobile Banking: Who is in the Driver’s Seat?

Amin Mohseni-Cheraghlou's picture

It is in the popular perception that technological availability and regulation are the two most important factors in promoting mobile banking, defined here as the usage of mobile phones to send/receive money and to make payments. Two cases, however, defy this common perception and bring forth interesting questions as to what are the main driving factors for mobile banking. Let’s take a brief look at Russia and Somalia.

  Russia and Somalia (2011)

Foreign banks in Mexico: is there a reason to worry?

There has been an ongoing debate regarding the consequences of foreign ownership in the banking sector in Mexico. Some participants in the public discourse argue that foreign ownership earnings leave the country in the form of dividends, leaving little, if any, for reinvestment. Another argument claims that foreigners are not interested in economic development in the country and thus restrict credit, especially to small and medium-size companies.

In this study (read Spanish version), we first analyze the theoretical underpinnings. According to Becker’s theory of discrimination, if one entity were to discriminate, the competition would take advantage of the money left on the table and would eventually take the discriminating entity out of the market or, at least, the entity would show subpar performance. In other words, discrimination in giving credit in the country would go against the best interests of the foreign-owned bank.

Credit Reporting under the Shadow of Big Banks

Subika Farazi's picture

Credit information sharing has been shown to have several benefits for the financial system. Reliable credit information can address the fundamental problem of asymmetric information between borrowers and lenders, it can alter borrowers’ behavior countering moral hazard, and improving repayment rates, and it can place banks in a better position to assess default risk, counter adverse selection, and monitor institutional exposures to credit risk. Perhaps most importantly, credit reporting can allow borrowers to build a credit history and to use a documented track record of responsible borrowing and repayment as "reputational collateral" to access credit outside established lending relationships. In addition, financial regulators can draw on credit reporting systems to understand the credit risk faced by financial institutions and systemically important borrowers, to define capital provisioning requirements, and to conduct essential oversight functions.

Despite the numerous benefits of information sharing for credit market efficiency, credit reporting institutions do not always emerge spontaneously. The Doing Business dataset shows that 26 percent of countries do not have any credit reporting institution at all (figure 1). Low and middle income countries have a relatively higher presence of credit registries while credit bureaus are more common in high income countries.

How Competition Affects the Performance of Microfinance Institutions in Bangladesh?

Shahid Khandker's picture

The spectacular expansion of microcredit programs in Bangladesh, including a growing number of borrowers availing credit from multiple microfinance institutions (MFIs), have brought recent concerns that MFI competition might be taking a toll on the industry in terms of reduced rates of loan repayment and a higher incidence of overlapping debt. Microfinance programs have been running in Bangladesh for more than two decades, reaching more than 10 million households, nearly half the rural population. By 2008, the annual disbursement of microfinance programs was close to US$1.8 billion with an outstanding balance of US$1.5 billion. The country’s wholesale microcredit agency, the Palli Karma Shahayak Foundation (PKSF), with support of the World Bank has orchestrated microfinance penetration through a wide network of small but highly competitive partner organizations.

Have Capital Markets Aided Growth in China and India?

Tatiana Didier's picture

Among the most notable developments in the global economy over the past 20 years has been the rise of China and India as world economic powers. Along with high overall growth in these economies has come an increase in their financial activity. But how much have different types of firms used capital markets and benefited from their expansion?

In a new study and VoxEU column, we argue that the expansion of financing to the private sector in China and India has been much more subdued than the aggregate measures of financial depth suggest. Although capital raising activity in equity and bond markets expanded substantially in 2005–10, it remained small as a percentage of GDP. Importantly, this expansion was not associated with widespread use of capital markets by firms. Not only have few firms made recurrent use of equity and bond markets; even fewer firms have captured the bulk of the capital market financing. Moreover, firms that use equity or bond markets are very different from—and behave differently than—those that do not do so. While non-issuing firms in both China and India grew at about the same rate as the overall economy, issuing firms grew twice as fast in 2004–11.

What factors triggered the liquidity risk of the mortgage SOFOLs in Mexico?

Eduardo Mendoza's picture

The year 1994 saw the birth of the SOFOLs[1] in Mexico. These societies are non-bank financial institutions (NBFIs). One feature of these institutions is that the financial resources they supply must be exclusively directed to funding a market niche, e.g. consumption credit, commercial credit, mortgages, or credit cards. Moreover, SOFOLs are not allowed to take deposits from the public. During 2000-2010, these institutions placed a significant amount of financial funds in almost every market niche, and many of them consolidated over time.

The stronger growth and best performance was registered by the SOFOLs that granted mortgages (mortgage SOFOLs). By the end of 2005 the financial resources granted by these institutions accounted for over 60% of the credit balance of all SOFOLs in México. However, their good performance did not last long: their funding flows and the number of societies began to decline in 2006. The global financial crisis of 2008 also affected their financial performance. See graph below.

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