Information Asymmetry and Trust: A Framework for Studying Microfinance in India

In this paper, the author investigates how trust is factored into the provider-client relationship in financial services. He investigates the microfinance sector and examines the various lending mechanisms to understand the effect of trust.

The paper is structured as follows:

• Study of the theoretical elements of microfinance in terms of:
  • Design of services;
  • Potential clientele demographics and behavioral patterns;
  • Delivery of microfinance services;
  • Optimum conditions for success of microfinance models.
• Institutional intermediation to address the financial needs of the rural poor:
  • Examines the gaps in the sector, especially in savings services for the rural poor;
  • Cites past and present examples to point out the absence of trust-based relationships in such institutions.
• Role of trust in exchanges:
  • Compares the trust element in conventional set-ups to that being fostered by microfinance/new institutional set-ups;
  • Argues that microfinance, by its nature, regards trust as an important element in the relationship.
• Relationship between trust and transaction costs:
  • With the lack of information on clients, the transaction costs increases;
  • Trust reduces some of these transaction costs by allowing relationships without exhaustive information.

The author concludes that rural markets may move beyond interpersonal trust towards contract based systems (prevalent in mature financial setups) in the future.

Finally, the document lists the degree of trust and transaction costs at various levels of financial transactions.