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An economic analysis of microcredit lending



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This study explores a number of the issues around the provision of micro-loans by credit unions and the agencies with which they work. One of the issues is how information asymmetry in the provision of microcredit and the resulting rationing of credit to low collateral entrepreneurs are addressed by the bundling of microcredit with the provision of non-financial services (e.g., mentoring). The other issue of interest is the advantages and disadvantages of investor-owned firms (IOFs) -- e.g., chartered banks -- versus credit unions in providing microcredit. Two models of the credit market with both adverse selection and moral hazard are set up to analyze credit rationing of low collateral entrepreneurs and the potential role of non-financial services as a selection instrument in mitigating information asymmetry. The first model investigates the situation where entrepreneurs cannot be distinguished by wealth and the second model looks at the situation where entrepreneurs cannot be distinguished by entrepreneurial skill. A model of a monopoly credit union is developed to examine whether credit unions have advantages over IOFs in providing microcredit. By offering a community investment saving deposit program, the credit union has access to loan funds for microcredit at below-market rates of interest. The model takes into account both pecuniary and non-pecuniary incentives of savers for participating in the saving program. A key result is that with information asymmetry, a perfectly competitive credit market will not produce the first-best efficient level of investment when collateralizable wealth is unavailable. Micro-entrepreneurs with insufficient collateral face credit rationing. Rationing arises because, in a perfectly competitive credit market, the collateral constraint limits lenders' ability to design a set of incentive-compatible contracts. In response, lenders randomize the credit delivered under the contract designed for the low collateral entrepreneurs to deter other entrepreneurs from choosing it. The smaller is the collateralizable wealth of the low collateral entrepreneurs, the greater is the credit rationing that occurs. This study provides a new explanation for the provision of non-financial services such as mentoring along with microcredit. Non-financial services have traditionally been seen as a way of providing training to borrowers and increasing the likelihood of them repaying their loans. The research in this thesis demonstrates that non-financial services can play a role in having borrowers select the types of loans they wish to obtain. The resulting separation means that the resources designated for micro-entrepreneurs will not be used by other entrepreneurs. The bundling of micro-loans with the provision of non-financial services imposes extra costs on entrepreneurs that obtain a micro-loan in comparison to a traditional loan. Assuming heterogeneity in the entrepreneurs' costs of obtaining a micro-loan, it is argued that entrepreneurs who are the target clients of microcredit programs incur the lowest cost of obtaining a micro-loan, while other entrepreneurs incur a relatively higher cost of obtaining a micro-loan. If this outcome occurs, then the higher cost discourages the latter from obtaining micro-loans. Thus, the use of non-financial services, along with the interest rate and collateral, in the loan contract results in a perfect separation and a more efficient level of investment. The analysis also suggests that credit unions, in comparison with IOFs, have advantages in providing microcredit to micro-entrepreneurs. Credit unions' advantage stems from their focus on the welfare of their members rather than on the profits earned. The result suggests that credit unions are likely to be more capable of successfully operating a microcredit program than are IOFs. All else equal, credit unions are able to obtain greater support from their saver members, and thus have more loan funds available for delivering microcredit. The result also suggests that the member orientation of a credit union can create a deadweight loss -- the stronger the credit union prefers one member group over the other group, the greater is the deadweight loss -- and thus have an impact on both the total benefits for members and the distribution of the benefits between micro-loan borrower members and saver members. Despite this, the presence of a credit union leads to a better outcome in terms of both the level of investment that is financed and the benefits to borrowers and savers.






Doctor of Philosophy (Ph.D.)


Agricultural Economics


Agricultural Economics



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