Paper
An Economic Framework for Understanding Microcredit in Developing Countries
How can a trust-based microcredit market co-exist with a commercial collateral-based market?
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18 pages
This paper investigates the economics of microcredit to reduce vulnerability and food insecurity. It presents a model that shows how a microcredit market based on trust can co-exist with a commercial collateral-based market. The model provides an economic structure to microcredit that is different from collateral-based models of lending. The model illustrates how:
- Grameen Bank operates microloans in Bangladesh;
- Non-endorsement of the notion of trust as a form of capital in China, has led to the very poor being excluded from the microcredit market;
- In India, MFIs and commercial banks have progressed into microcredit and other forms of finance and are being promoted by rural development NGOs;
- Microcredit lenders in India lend fundamentally on trust and are focused largely on the poor in rural areas;
- MFIs can co-exist with subsidized credit from government banks;
- Microcredit emergence has affected informal lending and usury rates from money lenders.
The theoretical model indicates that trust-based lending, coupled with certain incentives, can go far in supporting growth opportunities in developing countries. Development policy should be flexible enough to permit trust-based micro-lending to the poor.
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