2. Inefficiency in the credit market_________________________ 4
2.1 Credit constraints___________________________________ 4
2.2 Defining market failures in the credit market_____________ 6
3. Imperfect information in the credit market_______________ 7
3.1 Agency problems___________________________________ 7
3.2 Adverse selection___________________________________ 8
3.3 Moral Hazard______________________________________ 8
4. Microcredit: Group lending____________________________ 9
4.1 The method of group lending: example from Bangladesh____ 10
4.2 Overcoming adverse selection_________________________ 11
4.3 Overcoming moral hazard____________________________ 12
4.4 Limits to group lending______________________________ 13
5. The economic impacts of microcredit_____________________ 14
5.1 How microcredit affects households____________________ 15
5.2 Microcredit: does it work?____________________________ 15
6. Institutions and sustainability___________________________ 16
6.1 The failure of state-owned development banks____________ 16
6.2 Microcredit institutions_______________________________ 17
6.3 Cost-benefit analysis_________________________________ 17
6.4 Smart subsidies_____________________________________ 18
7. Conclusion____________________________________________ 19
8. References____________________________________________ 20
1. Introduction
Microcredit is a hot topic among economists and development specialists. The year 2005 was the UN International Year of Microcredit and last year, the Bangladeshi economist Muhammad Yunus, received the Nobel Peace Prize for his pioneering work in the credit market in Bangladesh. Yunus’ non-profit bank offers small loans to people that are not creditworthy. This loan can make the difference in rising people above the poverty line and giving them the opportunity to achieve higher living standards.
When Yunus visited some remote villages for the first time, he was shocked by the huge interest rates of over 150 percent, set by village moneylenders. He started wondering why commercial banks are not interested in getting these returns. After some research he concluded that a number of entry barriers exist for banks in developing countries to engage in this business. Lack of information is the critical one. Village moneylenders are better acquainted with the borrowers than banks, and they can keep out unreliable borrowers. Furthermore, they can monitor the behaviour of their clients closely and act on a small scale, which is impossible for banks. These advantages create small monopolies for village lenders in the credit market and this causes serious problems...

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