An Introduction to Microcredit: Why Money is Flowing from the Rich to the Poor

This paper examines how MFIs have overcome the obstacles to mobility of capital. Capital does not flow from the rich to the poor due to several problems. These include lack of complementary human capital, information asymmetries and transaction costs for small loan sizes. MFIs have succeeded in reducing information asymmetries and overcoming adverse selection by using rating agencies, getting guarantees and conducting auditor reports. They have improved risk evaluation by gathering increased information.MFIs obtain financing at costs that are lower than those of moneylenders. Reasons for their low cost of funds include:

• Donor funding that is free of cost;
• Funding from socially responsible investors and transnational institutions that provide soft loans with credit enhancement mechanisms and reduced interest rates;
• Commercial credit;
• Tax exemption;
• Higher interest rates charged by MFIs are not considered usurious or illegal as they have a socially responsible stamp;
• Benefits of risk and cost reduction;
• Banking status and access to cheap deposits.