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The Unknowns of Microfinance Microentrepreneurs and Their Money: Three Anomalies

This summary paper discusses three anomalies in microfinance: the low savings rate, the lack of joint production, and the limited growth of microenterprises. It presents possible reasons for these anomalies and explores their implications for microfinance institutions. The paper also highlights the importance of improving conditions in related markets to alleviate poverty effectively.

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The Unknowns of Microfinance Microentrepreneurs and Their Money: Three Anomalies

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  1. The Unknowns of MicrofinanceMicroentrepreneurs and Their Money: Three Anomalies Discussion Bilal Zia (World Bank)

  2. Summary Paper lists some interesting questions: Why do people borrow so often and not save? Why don’t people undertake efficient joint production? Why do people make sub-optimal investment and labor allocation decisions? … and provides a list of possible answers … and their take on the most likely answer

  3. Why don’t people save? The puzzle: Overnight borrowing rates are tremendously high, so why don’t people consume less today, and invest their savings into working capital tomorrow… Compounding these savings can help eliminate debt… Reasons: Self control problems – more severe at low wealth levels Lack of savings instruments Intra-HH bargaining conflicts Complexity – people do not understand compounding (some new work on this is being done)

  4. Why don’t people save? The puzzle: Overnight borrowing rates are tremendously high, so why don’t people consume less today, and invest their savings into working capital tomorrow… Compounding these savings can help eliminate debt… Reasons: Self control problems – more severe at low wealth levels Lack of savings instruments Intra-HH bargaining conflicts Complexity – people do not understand compounding (some new work on this is being done) Agreed… but why is this a “Microfinance” specific problem? (people borrow from payday lenders, daily banks, etc.)

  5. Why don’t people jointly produce? My take: Diversification of risks – two cows are better than one. Hypothetical example assumes ex-ante knowledge of ex-post return! Not clear this is the case, especially in more complicated business transactions “Tax” based on social capital – don’t want to destroy social capital… … then why do people still enter joint liability groups? Gine and Karlan (2006) do show evidence of “tax” Also, amt. borrowed may not constitute the entire “bread and butter” of individual, whereas production typically does

  6. Non financial market imperfections Improving conditions in related markets can help alleviate poverty better than simply focusing on improving finance… Agreed… but again, why is this “Microfinance” specific?

  7. Further Anomalies (I)… Pg. 3 of paper: “… the picture is one of widespread and frequent short-term borrowing… own capital is not sufficient to finance a minimum scale of business that appears invariant”

  8. Further Anomalies (I)… Pg. 3 of paper: “… the picture is one of widespread and frequent short-term borrowing… own capital is not sufficient to finance a minimum scale of business that appears invariant” First Order Question: Why do microfinance enterprises not grow?

  9. Microenterprise Growth Inhibitors… Anecdotally, few microenterprises grow beyond subsistence… Why? Is it lack of entrepreneurial talent? Is it contract structure? Microfinance institutions focus on minimizing default… Yet, not clear that socially optimal investment allocation will have zero default… If penalty for default v. high (socially ostracized, future borrowing disallowed, etc.)  People might opt for “safe” investment rather than one that maximizes returns. Stuck in “Safe Investment” trap! Repayment begins immediately, but investments often take time to reap rewards. Credit constrained individuals may be unable to undertake high yield investments.

  10. Further Anomalies (II)… If marginal returns are so high, why don’t banks lend to them? HHs choose not to borrow (fear of formal, inflexible debt, etc.) Banks lend based on Average Product rather then Marginal Product (diminishing returns may set in pretty sharply…) Although returns are high, variance may also be very high.

  11. Further Anomalies (II)… If marginal returns are so high, why don’t banks lend to them? HHs choose not to borrow (fear of formal, inflexible debt, etc.) Banks lend based on Average Product rather then Marginal Product (diminishing returns may set in pretty sharply…) Although returns are high, variance may also be very high. This question particularly puzzling since Karlan and Zinman (2006) show that accepting marginally rejected loan clients IS profitable and welfare improving…

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