Development Economics. Lecture 22: Credit Markets Professor Anant Nyshadham ECON 2273

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1 Developmet Ecoomics Lecture 22: Credit Markets Professor Aat Nyshadham ECON 2273

2 This lecture 1. Lumpiess ad time 1. Savigs 2. Isurace 3. Credit 2. Characteristics of credit markets for the poor 2

3 Lumpiess Much of our lives as cosumers or ivestors revolve aroud havig a big eough lump sum to do somethig Example: Movie theaters require the full ticket price to watch the movie It is ot possible to pay a smaller amout ad watch oly half the movie The lives of the rich are rarely costraied by such lumpiess q We would ever wat to watch oly half a movie ow ad half later eve if we could, because we always have the full ticket price 3

4 Lumpiess Some places where as cosumers we might be costraied by lumpiess q Cars q Houses q Large durable goods (dishwashers, big tv s) q Educatio expeses (college) Credit plays a importat part i every oe of these markets 4

5 Lumpiess I rich coutries, lumpiess happes frequetly i ivestmets q Fixed cost of busiess is required before ay moey ca be made Example: Restaurats, for example, have to ret ad remodel space, hire chefs ad waiters, buy equipmet, prit meus, all before make ay moey May ivestmets ca oly be made or are oly worth makig i lumps q They are ot divisible q For example: restaurats eed to be big eough to have both a kitche ad several tables 5

6 Lumpiess For rich people, lumpiess is ot much of a problem, we ca afford to pay ow ad use over time Poor people do ot have that luxury q Example: shampoo Bottles of shampoo ofte represet 100 of washigs, ad possible several days wages for poor family That may mea it is a big ivestmet for a poor family Markets have created idividual use shampoo packets sold maily i poor coutries (but more expesive per use) q Some thigs caot be split apart that way Bullocks, bicycles, laters, TV s, school fees, eve weddigs ad fueral spedig 6

7 Lumpiess ad fiacial itermediatio Lumpiess requires people to gather together sizeable sums of moey at oe time q The poor, because they are poor, are particularly costraied by lumpiess i cosumptio or ivestmet Sometimes the poor borrow directly from each other or merchats Sometimes they use itermediaries such as baks, moey leders or micro-fiace orgaizatios Fiacial itermediatio: the process of movig fuds from those who have some ow, to those who wat some ow 7

8 Lumpiess Basic fiacial itermediatio for the poor takes o three forms (Rutherford 1999) 1. a savigs service that allows you to accumulate savigs first ad take the resultig lump sum later 2. a loa service that allows you take the lump sum first as a advace agaist future savigs 3. a isurace service that allows you to take a lump sum at the time it is eeded i exchage for a cotiuous stream of savigs 8

9 Savigs Save a small amout o a regular basis, which evetually adds up to a larger amout Problems for savig q q Ofte o good way savigs ca be stole, lost, destroyed Claims o savigs difficult to dey eighbor, fried, or husbad if have the moey o had Simplest savigs services for the poor q Deposit collector, who gathers small amouts from cliets, ad the pays out a agreed sum Source: Rutherford, Stuart (1999) The poor ad their moey ( readigs/poormoey.pdf) 9

10 Savigs: ROSCAs Rotatig Savigs ad Credit Associatios (ROSCA) q A group of people get together each week (say 14 people) q Each perso puts i a agreed amout (say oe day s wages) q They all agree to give the total amout to oe perso i the group q Every 14 weeks each perso gets a payoff of 2 weeks wages, i retur for havig saved oe day s wages each week q Group eeds to decide how to pick the perso who gets each paymet q Problems with ROSCAs: flexibility, fraud 10

11 Savigs: ROSCA How to decide who gets moey whe: q Sometimes radomly: shuffle ames, everybody gets a tur over 14 weeks, the repeat i ext 14 weeks q Sometimes group decides to let people move ahead, so it becomes a credit associatio q Sometimes group lets people bid o how much they eed it so group ca make profit 11

12 Isurace Save a small amout o a regular basis, ad the get a big payoff whe it is really eeded q Example: fuerals are very expesive i may parts of Africa, but it is ucertai whe they will occur Very commo to form burial associatios, which payout o death for a big fueral q Example: Marriage fuds for daughters have a similar purpose i South Idia they pay off whe (if) your daughter gets married 12

13 Credit Get a big lump sum ow, i retur for paymets i the future (ofte small paymets) Simplest form: the local moeyleder q Go to the local moeyleder for a loa, have to pay back, with iterest, over time 13

14 Complex fiacial istrumets The poor, just like the rich, are very creative i comig up with ew fiacial istrumets to suit their eeds Combie savigs, credit, ad isurace Examples q q q Deposit collector may give a advace o the big payout (savigs+credit) ROSCAs may allow people to jump i lie, or bid o who gets the lump sum (savigs + credit + isurace) Moeyleders may be willig to delay paymet if somethig bad happes (isurace+credit) 14

15 Complex fiacial istrumets Save, but ca borrow whe eed to (so the advace works like isurace) Source: Rutherford, Stuart (1999) The poor ad their moey ( 15

16 Credit Markets for the poor I Baerjee ad Duflo (2007) The Ecoomic Lives of the Poor q Poor ofte take loas, but geerally ot from formal leders q Ofte from frieds ad family at low rates of iterest q Ofte from moeyleders at very high iterest rates q Low rates of default, that we ca observe Credit from may ot be the most importat istrumet the poor use to maage their fiaces q But it has received most attetio 16

17 Characteristics of credit markets for the poor Ted to be iformal Difficulty of legal eforcemet: leders ofte have little legal recourse (but may ofte use extra-legal approaches) Iformatioal costraits: ca t observe all ecessary/ useful iformatio Segmetatio: moeyleder teds to serve a group mostly from the surroudig area, ot much competitio Repeat ledig: leders more likely to led to previous cliets Iterlikages: ledig may be part of a larger relatioship 17

18 Characteristics of credit markets for the poor Iterest rate variatio: Iterest rates are geerally high, but ca vary substatially Ratioig: borrowers are limited i how much they ca borrow, at ay rate of iterest Exclusivity ad moopoly: moeyleders typically wat to be the oly source of credit for their cliets q A moopoly o ledig allows rates to be high by restrictig supply q Explais ratioig ad high iterest rates q Probably part of the problem for poor, but ot all of it Moeyleders seem to be commo i developig coutries Eve i US, payday loas are competitive, with may compaies competig yet still charge high rates 18

Chapter Four Learning Objectives Valuing Monetary Payments Now and in the Future

Chapter Four Learning Objectives Valuing Monetary Payments Now and in the Future Chapter Four Future Value, Preset Value, ad Iterest Rates Chapter 4 Learig Objectives Develop a uderstadig of 1. Time ad the value of paymets 2. Preset value versus future value 3. Nomial versus real iterest