Credit Markets: Basic Problems and Past Policies October 2008 () - - PowerPoint PPT Presentation

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Credit Markets: Basic Problems and Past Policies October 2008 () Credit Market Problems October 2008 1 / 13 Basic Problems (circa 1950): Low quantity of domestic savings major constraint on investment, especially in manufacturing ()

SLIDE 1

Credit Markets: Basic Problems and Past Policies

October 2008

() Credit Market Problems October 2008 1 / 13

SLIDE 2

Basic Problems (circa 1950):

Low quantity of domestic savings — major constraint on investment, especially in manufacturing

() Credit Market Problems October 2008 2 / 13

SLIDE 3

Basic Problems (circa 1950):

Low quantity of domestic savings — major constraint on investment, especially in manufacturing Dualistic credit market

() Credit Market Problems October 2008 2 / 13

SLIDE 4

Basic Problems (circa 1950):

Low quantity of domestic savings — major constraint on investment, especially in manufacturing Dualistic credit market ֒ → formal sector — commercial and government run banks serving urban sector and large landowners

() Credit Market Problems October 2008 2 / 13

SLIDE 5

Basic Problems (circa 1950):

Low quantity of domestic savings — major constraint on investment, especially in manufacturing Dualistic credit market ֒ → formal sector — commercial and government run banks serving urban sector and large landowners ֒ → informal sector — small scale lenders and agricultural cooperatives serving small scale rural borrowers and the informal urban sector

() Credit Market Problems October 2008 2 / 13

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Basic Problems (circa 1950):

Low quantity of domestic savings — major constraint on investment, especially in manufacturing Dualistic credit market ֒ → formal sector — commercial and government run banks serving urban sector and large landowners ֒ → informal sector — small scale lenders and agricultural cooperatives serving small scale rural borrowers and the informal urban sector Skewed distribution of credit access — a source of persistent and widening wealth disparity.

() Credit Market Problems October 2008 2 / 13

SLIDE 7

The Development Planning View

Dominant paradigm (1960s / 70s)

Monopolistic moneylenders, especially in rural areas

() Credit Market Problems October 2008 3 / 13

SLIDE 8

The Development Planning View

Dominant paradigm (1960s / 70s)

Monopolistic moneylenders, especially in rural areas Lack of “financial depth”

() Credit Market Problems October 2008 3 / 13

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The Development Planning View

Dominant paradigm (1960s / 70s)

Monopolistic moneylenders, especially in rural areas Lack of “financial depth” ֒ → low savings due to uncertainty regarding potential bank failure and ineffective legal systems

() Credit Market Problems October 2008 3 / 13

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The Development Planning View

Dominant paradigm (1960s / 70s)

Monopolistic moneylenders, especially in rural areas Lack of “financial depth” ֒ → low savings due to uncertainty regarding potential bank failure and ineffective legal systems ֒ → lack of alternatives financial assets catering to varying needs of potential savers/lenders.

() Credit Market Problems October 2008 3 / 13

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Interest Rate Loans L r

M M

MR MC D(r) AC r Figure: Monopoly Lender

() Credit Market Problems October 2008 4 / 13

SLIDE 12

Policy Strategy:

“put the moneylender in his place”

() Credit Market Problems October 2008 5 / 13

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Policy Strategy:

“put the moneylender in his place” ֒ → development banks to lend at low rates to rural borrowers

() Credit Market Problems October 2008 5 / 13

SLIDE 14

Policy Strategy:

“put the moneylender in his place” ֒ → development banks to lend at low rates to rural borrowers initially fill savings gap with tax revenue and foreign loans/aid

() Credit Market Problems October 2008 5 / 13

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Policy Strategy:

“put the moneylender in his place” ֒ → development banks to lend at low rates to rural borrowers initially fill savings gap with tax revenue and foreign loans/aid Eventually banks would become self–financing

() Credit Market Problems October 2008 5 / 13

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Policy Strategy:

“put the moneylender in his place” ֒ → development banks to lend at low rates to rural borrowers initially fill savings gap with tax revenue and foreign loans/aid Eventually banks would become self–financing BUT

() Credit Market Problems October 2008 5 / 13

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Policy Strategy:

“put the moneylender in his place” ֒ → development banks to lend at low rates to rural borrowers initially fill savings gap with tax revenue and foreign loans/aid Eventually banks would become self–financing BUT ֒ → failed to drive out informal moneylenders

() Credit Market Problems October 2008 5 / 13

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Policy Strategy:

“put the moneylender in his place” ֒ → development banks to lend at low rates to rural borrowers initially fill savings gap with tax revenue and foreign loans/aid Eventually banks would become self–financing BUT ֒ → failed to drive out informal moneylenders ֒ → development banks did not become financially viable

() Credit Market Problems October 2008 5 / 13

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Policy Strategy:

“put the moneylender in his place” ֒ → development banks to lend at low rates to rural borrowers initially fill savings gap with tax revenue and foreign loans/aid Eventually banks would become self–financing BUT ֒ → failed to drive out informal moneylenders ֒ → development banks did not become financially viable ֒ → access to formal credit remained skewed towards large landowners

() Credit Market Problems October 2008 5 / 13

SLIDE 20

The Chicago School View

Informal sector is competitive, but risky and costly due to

() Credit Market Problems October 2008 6 / 13

SLIDE 21

The Chicago School View

Informal sector is competitive, but risky and costly due to ֒ → seasonal activity

() Credit Market Problems October 2008 6 / 13

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The Chicago School View

Informal sector is competitive, but risky and costly due to ֒ → seasonal activity ֒ → systemic risk

() Credit Market Problems October 2008 6 / 13

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The Chicago School View

Informal sector is competitive, but risky and costly due to ֒ → seasonal activity ֒ → systemic risk ֒ → geographically dispersed customers

() Credit Market Problems October 2008 6 / 13

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The Chicago School View

Informal sector is competitive, but risky and costly due to ֒ → seasonal activity ֒ → systemic risk ֒ → geographically dispersed customers ֒ → absence of collateral — land is often untitled

() Credit Market Problems October 2008 6 / 13

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The Chicago School View

Informal sector is competitive, but risky and costly due to ֒ → seasonal activity ֒ → systemic risk ֒ → geographically dispersed customers ֒ → absence of collateral — land is often untitled ֒ → difficulty of enforcing repayment

() Credit Market Problems October 2008 6 / 13

SLIDE 26

The Chicago School View

Informal sector is competitive, but risky and costly due to ֒ → seasonal activity ֒ → systemic risk ֒ → geographically dispersed customers ֒ → absence of collateral — land is often untitled ֒ → difficulty of enforcing repayment ⇒ lack of information reflects acquisition costs

() Credit Market Problems October 2008 6 / 13

SLIDE 27

The Chicago School View

Informal sector is competitive, but risky and costly due to ֒ → seasonal activity ֒ → systemic risk ֒ → geographically dispersed customers ֒ → absence of collateral — land is often untitled ֒ → difficulty of enforcing repayment ⇒ lack of information reflects acquisition costs ⇒ high interest rates reflect risk not monopoly power

() Credit Market Problems October 2008 6 / 13

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Lender’s risk hypothesis: Profit per $ loaned = p(1 + r) − (1 + i) where r = lending rate i = marginal cost of funds p = probability of repayment

() Credit Market Problems October 2008 7 / 13

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Lender’s risk hypothesis: Profit per $ loaned = p(1 + r) − (1 + i) where r = lending rate i = marginal cost of funds p = probability of repayment ֒ → Competition ⇒ zero economic profits

() Credit Market Problems October 2008 7 / 13

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Lender’s risk hypothesis: Profit per $ loaned = p(1 + r) − (1 + i) where r = lending rate i = marginal cost of funds p = probability of repayment ֒ → Competition ⇒ zero economic profits ֒ → risk–adjusted interest rate r = 1 + i p − 1

() Credit Market Problems October 2008 7 / 13

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