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This chapter draws on Armendariz de Aghion and Morduch 2000.

1. Renegotiation occurs by transferring problem borrowers from standard "basic" loans to "flexi-loans" with longer terms and smaller installments, but by early 2004 the practice was not yet common at Grameen.

2. Data are from, as posted in May 2003.

3. Village banks operate by placing everyone in the village into one large group with mutual responsibility. Group meetings are often used for training sessions as well as financial matters. For more on village banking, see and Karlan 2003.

4. The work of SafeSave in the slums of Dhaka is one example.

5. A credit agency can help address this problem, such that banks can investigate credit histories of prospective clients, but we know of no such agencies serving microfinance populations.

7. See Armendariz de Aghion 1999 for a framework where peer monitoring costs are explicitly taken into account. Specifically, if peer monitoring is exceedingly costly, individual (i.e., bilateral lender-borrower) contracts are shown to dominate over group-lending contracts.

8. In the sovereign debt case, there is no international court where foreign creditors can enforce claims on a country, so there can be no use of collateral either. See Bulow and Rogoff 1989a, 1989b.

9. This turns out to be an important assumption. If the borrower could default and hold onto enough principal to easily finance future business operations, the threat of non-refinancing would be considerably weakened. See Bond and Krishnamurty (2001) for a discussion of assumptions needed for threats of non-refinancing to have teeth when this is the case.

10. The model rests on the assumption that the bank can credibly commit to provide a second-period loan, even though it anticipates this new loan will be defaulted upon, which may seem unrealistic. However, it will all depend on the interest rate that the bank charges, which in this setup will be endogenously determined. Note that the probability of default will be substantially reduced in an infinite horizon model. In particular, we know by the "folk theorem" of game theory, that if the discount factor, 8, is large enough, strategic defaults will never be observed in equilibrium. See, for example, Fudenberg and Maskin 1986.

11. This expression reduces to 8y(j - u) < 8y(1 - v) if a nondefaulting borrower is refinanced only with probability j < 1.

12. Note that the maximum enforceable repayment R = 8y satisfies the "individual rationality constraint" of the borrower; namely, y - R + 8y > 0. This constraint states that an individual borrower must find it profitable to enter into a contractual obligation with the bank—otherwise, they refuse to borrow in the first place.

13. One more step is actually needed. It has to be checked that the interest rate satisfies the borrower's "individual rationality" constraint—namely, is it worth it for the borrower to borrow at that rate?

14. See Hoff and Stiglitz 1998.

15. The Bolivian experience is described by Rhyne 2001, chap. 7, from which this account is taken.

16. Data on number of clients are from Rhyne 2001, 142. Data on overdues rates are from pp. 148-149, and data on BancoSol's return on equity are from p. 149.

17. The story is related in Rhyne 2001, 145.

18. Grameen Bank, Annual Report 1995 and Annual Report 2000 (Grameen Bank 1996, 2001). Matin (1997) tells a richly observed story of how "overlapping" led to severe difficulties in villages in Tangail.

19. Grameen Bank's "Grameen Bank II" is the most notable example (Yunus 2002)— although it remains too new to assess and observers have concern that the ease with which loans can be rescheduled under the new system will unduly exacerbate moral hazard.

20. The need for credit bureaus is made forcefully by Mcintosh and Wydick (2002) who show cases where, in principle, competition can worsen the lot of the poorest households. Competition can, in particular, make it difficult to cross-subsidize the poorest borrowers.

21. Data on Bolivia are reported by Gonzalez-Vega et al. (1997), 74.

22. A theoretical formalization of this notion would follow the treatment of repeated lending contracts described in Parikshit Ghosh and Debray Ray (1997).

23. Morduch interview with Fazle Abed, founder and chairperson of BRAC, Dhaka, December 2002.

24. Of course, part of the early installments can be (and often is) paid directly from the not-yet-invested principal of the loan. This makes the effective loan size smaller. The practice does not fully answer the puzzle at hand, since it cannot explain the bank's logic in requiring that the first installments are paid so soon. The bank, of course, might not be acting fully logically, but we suspect that there is more to it than that.

25. Jain and Mansuri (2003) offer a different but related story. They argue that if borrowers must resort to informal lenders (rather than the flow of other income coming into the household), then the microlender can piggyback on the informal lender's informational advantage. In other words, if you can't get a microloan without also getting a short-term loan from the moneylender to pay for the initial microloan installments, then only people judged to be creditworthy by moneylenders will demand microloans. The microlender gains due to this implicit screening mechanism. The mechanism is plausible in theory, but we do not know of any evidence that gives it empirical credence. Instead, other family income is most typically used to pay for initial installments, and it is unclear that this would provide the same kind of helpful piggybacking described by Jain and Mansuri.

26. Our discussion here is influenced heavily by conversations with staff members at Bank Rakyat Indonesia about how they determine loan terms and by Stuart Rutherford 2000, which considers lending mechanisms in the context of savings problems. We present a more "formal" discussion in Armendariz and Morduch (2000).

27. The survey of customers and non-customers was completed by Bank Rakyat Indonesia and analyzed by Morduch.

28. Personal communication with Don Johnston, a resident advisor to BRI in Jakarta, January 29, 2003.

29. BRI's policy is consistent with the view of collateral as a lever to improve credit contracts. In some cases, requiring collateral may be a lender's way of obtaining assets from the poor. Ray (1998), for example, argues that in India moneylenders sometimes require collateral and are pleased when borrowers default since it allows asset transfers from poor borrowers to wealthier moneylenders. This is not the case in microfinance.

30. Product data are from personal communication with Stuart Rutherford, January 2004. Similar data are available at

31. Data are from Stuart Rutherford, personal communication, January 2004.

32. Morduch personal communication with Monique Cohen, president of Microfinance Opportunities, an organization based in Washington that is focused on better understanding how microfinance customers use financial services, March 2004.

33. This story is related in Rai and Sjostrom 2004, drawing on Espisu et al. 1995. An alternative explanation of the story offered by Stuart Rutherford is that "people pay when they are asked to, and tend not to pay if they're not asked (the oldest rule in banking)."

34. Thus, a lender like SafeSave, that bases its operations on one-on-one visits by staff to client homes rather than public transactions, has one less lever to use in maintaining internal control.

35. The data from Hossain 1988, Hulme 1991, and Gibbons and Kasim 1991 is taken from Hulme and Mosley 1997 as cited in Wright 2000, 23.

36. Morduch interview with George Oetomo, general manager for operations, Yayasan Dharma Bhakti Parasahabat (, March 2003.

37. Churchill (1999) describes similar monitoring and information-collection mechanisms in individual lending programs run by the Alexandria Businessman's Association in Egypt and the Cajas Municipales of Peru, and he is the source for the information on Financiera Calpia cited previously.

38. Armendariz de Aghion (1999) provides an alternative view. 6 Savings and Insurance

1. BRI's coverage is particularly impressive given that the population of Indonesia is roughly 225 million. One way in which BRI deposits are less convenient is that clients have not been able to deposit or withdraw at any branch other than their local unit, although with ongoing computerization that limit should be overcome.

2. Personal communication with Stuart Rutherford, December 2002.

3. See, for example, the approaches taken by Galor and Zeira (1993), Banerjee and Newman (1993), and Aghion and Bolton (1997).

4. Program details and the survey results below are from Women's World Banking 2003.

5. In collecting deposits from the broader community, Grameen is taking full advantage of their official status as a bank, not an NGO. Thus, Grameen can do what ASA, BRAC, and other rivals cannot do as of this writing: Grameen can collect savings from clients who do not borrow.

6. Deaton 1992 remains an essential reference.

7. Personal communication with Stuart Rutherford, December 2003.

8. Field experience in Chiapas, Mexico reveals that poorer clients typically have time horizons that are rather short, leaving us pessimistic about prospects for long-term savings products in that context.

9. Blanchard and Fischer (1989) provide a guide to newer work in this spirit, building up from dynamic optimization problems under uncertainty.

10. For a more thorough and general treatment of the problem, see Deaton's excellent exposition (1992) and the lecture notes collected in Blanchard and Fischer (1989).

11. See Morduch 1999a for further evidence on addressing risk through informal mechanisms. Jalan and Ravallion's evidence is derived from a similar framework that focuses on risk-sharing within communities rather than intertemporal consumption smoothing per se. The frameworks, though, tend to capture similar difficulties—that consumption and income track each other more closely than households would like.

12. One approach would be to distinguish between the role of initial income when shocks are negative (creating a case in which borrowing constraints are expected to bind), versus situations in which shocks are positive (creating a case in which savings constraints are more apt to bind).

13. See Rutherford 2000 for a rich description of some common (and some not so common) mechanisms.

14. See Morduch 1999a for more on the hidden costs of informal mechanisms and related inefficiencies.

15. Specifically, de Meza and Webb (2001) argue that when adverse selection leads to credit rationing in the model of Stiglitz and Weiss (1981), borrowers face an infinite marginal cost of funds. As a result, they're better off delaying the project to accumulate more wealth. Continued delay means more wealth, reducing the need for credit.

16. In a similar way, it may be difficult to keep funds away from your spouse. As noted earlier, Anderson and Baland (2002) find that women in Nairobi save in ROSCAS in order to keep money out of the house and away from husbands. When it is harder to keep money from your spouse, it will be harder to accumulate savings.

17. BRI also provides depositors with coupons for a semiannual lottery. The chance of winning is proportional to the size of account and lotteries are much—anticipated local events. Awards range from a car or motorcycle to clocks, radios, and washing machines; overall, the value of awards in 1995 was about 0.7 percent of balances. (BRI Unit Products, p. 17, Jakarta: BRI.) In January 2003, the maximum interest rate on SIMPEDES deposits was 9.5 percent per year.

18. The literature on microinsurance (most of it oriented toward practitioners) is growing. Institutions such as the Grameen Bank and SEWA have long offered insurance products, and today organizations including the International Labor Organization and Micro-Save Africa are taking up the cause. The CGAP microfinance gateway (available at has links to a range of resources. Introductions to the literature include Brown and Churchill 1999, 2000 and, from a broader vantage, Morduch 2002b.

19. Data are from the CGAP Microfinance Gateway, "Earthquake in Gujarat: SEWA delivers on insurance claims," an article from 2001. Available at www

20. For more on rainfall insurance, see Miranda 1991 and Morduch 2002b.

21. Todd (1996) and Rahman (2001) describe situations where difficulties emerged; bear in mind, though, that they are not necessarily representative.

22. In the first two years since Grameen Bank II has been implemented, field reports indicated that loan officers have been reluctant to adopt the new, flexible lending mechanism. One reason is that the flexibility also brings more variation, and that makes it more costly to keep track of clients. Grameen's push toward full computerization will help, but the fruits are not yet evident in this regard. Another reason for the reluctance to embrace the new flexibility is fears that giving too much latitutde may inadvertently undermine repayment discipline. Another reason for the slow adoption is simply that loan officers need to get used to the new rules and will begin to adopt them over time.

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