Abstract
We analyze in this paper how various forms of state intervention can impact microfinance institutions’ lending behavior. Using a simple model where entrepreneurs receive individual uncollateralized loans, we show that, not surprisingly, state intervention through the loan guarantee increases the number of entrepreneurs receiving a loan. However, after modeling business development services (BDS) provided by the microfinance institution, we show that the loan guarantee can have a counterproductive effect by reducing the number of entrepreneurs benefiting from such services. We therefore analyze an alternative policy: BDS subsidization. We show that if BDS are efficient enough and are targeted toward less performing borrowers, then—for fixed government expenditures—such subsidies do better in terms of financial inclusion than the loan guarantee. Moreover, we argue that—under similar conditions—BDS subsidization alone does better in terms of financial inclusion than a mix of policies.
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Notes
Individual lending, as well as state intervention, are classical in developed countries and are spreading in developing ones. For a discussion about government intervention in microfinance in Latin America see the article “Governments in microfinance: threat or opportunity?” by Bate at http://www.iadb.org/en/news/webstories/2007-11-09/governments-in-microfinance-threat-or-opportunity,4134.html, accessed 21 November 2013.
For detailed definitions of different types of credit rationing (see Jaffee and Stiglitz 1990, pp. 847–849).
For example, the European Commission and the European Investment Bank started providing loan guarantee for microcredits in the European Union by launching the European Progress Microfinance Facility in 2010.
Cull et al. (2007) confirm the existence of MFIs having achieved the “ultimate promise of microfinance” (i.e., self-sustainability and large outreach to the poor). However, according to this study such MFIs are mainly exceptions.
For a discussion on the reasons of shifting from group lending to individual lending see the article by Yunus “Grameen Bank II: Lessons Learnt Over Quarter of A Century” at http://www.grameen.com/index.php?option=com_content&task=view&id=30&Itemid=0, accessed 22 November 2013.
For detailed examples of MFIs providing (themselves or not) non-financial services (see Dunford 2001).
Risk aversion of borrowers won’t impact our results, as there are no first derivative effects.
We, however, assume here that the actual investment and the success of the project are verifiable. In other words, we do not consider the case where delinquent borrowers cannot be compelled to reimburse their credit (see Anderson et al. 2009).
We keep these assumptions on the viability of the project for the rest of this paper. The presentation of the conditions on NPV changes when the loan guarantee and BDS are introduced. Because of their limited interest we do not present them for each model. Note that they do not alter our results.
Note that the minimal threshold for the project return is indeed always >1 + r. This will always be the case in the rest of the paper.
A stronger moral hazard issue consists in the incentive for the borrower not to leave with the cash. In our model, this constraint would correspond to \(\overline{p}\) being high enough. Still, it seems that in real world such an incentive is driven by future borrowing opportunities and sustainable financial inclusion (for example through the inclusion in the mainstream banking sector by the creation of a credit history). A more complete model would therefore include the value of future opportunities—from the viewpoint of the borrower—in case of success. This will not change our results. More precisely, in the case of a net present value of future borrowing opportunities V, independent of project’s present return \(\rho\), this would just add a term −V/D to Eq. (2). This term being present in all the models presented hereafter, it does not impact our comparisons and conclusions.
For example, in France, several public organisms guarantee capital in case of loss: the “Fonds de Cohésion Sociale” or Caritas (50 % of the outstanding principal and unpaid interest) for consumer loans (that aim at financing goods that contribute to job seeking, such as cars, computers, business suits) and “France Active Garantie” (70 % of the outstanding principal) for self-employment or small business loans. These guarantees are free from the MFI’s point of view. More recently the European Commission and the European Investment Bank started providing up to 75 % guarantee for microcredits in the European Union through the European Progress Microfinance Facility.
According to Brabant et al. (2009), it is cheaper—in the case of France—to subsidize entrepreneurship than to pay welfare benefits to microborrowers.
Such an analysis would still be very difficult to implement, as noted in Armendariz and Morduch (2010).
In a broader model, BDS could be correlated with the level of effort put in the project, its intrinsic quality or the entrepreneur’s ability.
Assuming complementarity between BDS and effort, the condition in Lemma 1 becomes weaker \(\frac{\varepsilon }{\overline{p}}+\frac{\psi }{D}\cdot \frac{\Delta p_{\varepsilon } - \Delta p}{\Delta p \Delta p_{\varepsilon }}(\overline{p}+\varepsilon )>\frac{K}{D}\), where \(\Delta p_{\varepsilon }>\Delta p\) represents the difference between the probabilities of success with and without effort in the presence of BDS. Moreover, if \(\Delta p<\Delta p_{\varepsilon }\), then \(\rho _{\varepsilon }<\rho _{\rm min}\) would not necessarily imply \(r_{\varepsilon }<\overline{r}\).
For the sake of simplicity we assume that the guarantee rate adjusts such that the total expected expenditure in the case of the loan guarantee is equal to the total expenditure in the case of full subsidization of BDS. An alternative strategy could be considering partial subsidization of BDS.
\(n_{\varepsilon }\) is smaller or equal to n as we have seen in Sect. 4.2 that the MFI is indifferent between offering or not BDS to clients with project returns higher than \(\rho _{\gamma }.\) The MFI might have an incentive not to offer BDS to all the borrowers due to capacity constraints.
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Acknowledgments
The authors thank Martha Alatriste, Mohamed Belhaj, Katarzyna Cieslik, Dominique Henriet, Marek Hudon, Robert Lensink, Patrick Pintus, Ariane Szafarz, Tanguy Van Ypersele, the associate editor and two anonymous referees for valuable comments and constructive suggestions.
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Bourlès, R., Cozarenco, A. State intervention and the microcredit market: the role of business development services. Small Bus Econ 43, 931–944 (2014). https://doi.org/10.1007/s11187-014-9578-0
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DOI: https://doi.org/10.1007/s11187-014-9578-0