Micro-credit, Financial Access, and Growth

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There is a well-established link between financial market development and growth rates at the aggregate level. Economists working on financial markets in developing countries have also investigated extensively how financial arrangements affect households and businesses, particularly how contracting and market frictions due to transactions costs and informational constraints may limit borrowing opportunities of the poor and can even lead to poverty traps. However, our understanding of the link between the micro and macro pictures remains limited. Policy makers and NGOs, particularly in the guise of micro-finance institutions (MFIs) are squarely behind the need to extend finance as a means of raising productivity and fostering institutional change, particularly to increase entrepreneurship and growth in low-income environments. However, for such strategies to flourish and to be effective, they need the tools to understand the impact of alternative strategies for extending credit. To aid this there has been an increase in evaluation studies of micro-finance. In addition, there have been some randomized-control trials which either vary access to micro-finance or the form that it takes. But so far the findings have been mixed. The results from randomized trials in various countries suggest that microfinance has a positive effect in starting small businesses, but somewhat discouragingly, it often does not have a statistically significant effect on poverty reduction or growth. At the same time there have been rising concerns about the effects of competition and for-profit organisational status for the microfinance industry. Given the current state of knowledge and evidence, we are still some way short of being able to offer clear-cut policy guidance based on these studies. This project uses a model of financial contracts in imperfect credit markets to explore a range of issues relevant to the improving access to finance in low income environments. The focus of the research is on understanding how technologies which improve credit access affect productivity and welfare. The approach will focus on how the wealth and productivity distribution among actual and potential entrepreneurs affects take-up of finance in different environments including, for example, how competition affects outcomes. It provides a vehicle for understanding the links between financial contracts on the ground and aggregate outcomes as well a means of interpreting the results from evaluation studies. The model that we propose can be calibrated to the data using a range of empirical estimates. There are five main directions of new research: (i) understanding different lending technologies, the lenders' choice of financial contracts and their implications for borrowers (ii) looking at financial organization design and the effect of the competitive context (iii) exploring the aggregate effects from credit market policies (iii) looking at entrepreneurship and access to finance (iv) exploring how credit market frictions can create poverty traps.The output of the research will be useful in shaping credit market policies and the business strategies of MFIs. Our collaboration with Bandhan, an MFI based in Kolkata, will allow us to explore how the tools that we developed can be tailored to the needs of a specific MFI and integrated into the data bases that they have on their clients and locations of projects. The proposal will aim to build the capacity of staff in academic institutions and in Bandhan to use the tools and develop them. The cooperation with Bandhan will also allow us to undertake research projects which require new data collection. This will create a back-and-forth between the economic modelling and field experience. Equally importantly, our research will put forth a framework to guide the choice of credit market policies. As a tool for a policy, it enables alternative interventions to be examined.