The Impact of Microfinance on the Informal Credit Market: An Adverse Selection Model
This paper studies the potential impact of microfinance on access to credit for non-members or the residual credit market. It examines joint liability in group lending as an instrument to limit adverse selection.
The paper observes that the existing literature has not yet touched the redistributive question of the microfinance revolution and this study is a contribution in that direction. It uses a model of a rural credit market under adverse selection to explain how entry of MFIs in the market can contribute to increase in equilibrium interest rates of traditional lenders. The key findings of this study are:
- Growth of MFIs may force moneylenders to relax credit constraints on relatively safe individuals or raise interest rate of the residual market;
- Two contradictory effects, namely competition effect and selection effect, coexist;
- Poor borrowers with no access to MFIs may be the most adversely affected by growth of MFIs.
The paper identifies areas for further research such as moral hazard issues, enforcement externalities between competing institutions and use of dynamic group formation and competition frameworks.
