ABSTRACT
Over the last two decades, there has been an explosive growth of interest in microfinance as a tool for alleviating poverty. One important reason for this is that microfinance satisfies the twin goals of economic development and the inclusion of marginalized people, reducing the mismatch between individuals with talent but no wealth and those with wealth and no talent. Even though it is obvious that not all loans end up in the hands of talented individuals, microfinance has this potential. Another reason is that in the field of banking, microfinance represents a breakthrough innovation that extends access to credit to the ‘unbankable’—that is, to individuals lacking financial resources that can be used as collateral for the sums borrowed. Microfinance is an innovation that can make an important contribution to sustainable development and the conditional convergence of developing countries to the level of economic well-being in developed countries. As shown in Chapter 4 of this volume, conditional convergence is a conceptual framework that has been influential in empirical studies of growth and establishes that lessdeveloped countries can begin to catch up to developed ones by bridging the gaps through convergence factors such as human capital, physical capital, physical and digital infrastructure, and quality of institutions. A microeconomic analysis of the laws governing economic growth shows that a crucial convergence factor is the pursuit of equal opportunities (Aghion et al. 1999). At the beginning of the industrial revolution, capital accumulation was the priority and a degree of inequality was necessary in order to allow higher savings by the rich to fuel economic growth. Today, however, financial resources are abundant at the world level, and the growth potential of a given country is achieved when all its inhabitants have access to credit and education and can fully exploit their talents. By providing access to credit for the ‘unbankable’,
microfinance marks an important step forward in assuring such access and reconciling equal opportunities and economic development. In terms of the specific contributions made by microfinance institutions (MFIs), the microfinance revolution marks the passage from the second to the third stage of development in the financial system. The first stage is characterized by individual moneylenders who were the only source of finance in preindustrial societies and still perform this role in villages of less developed countries. The second stage began with the rise of the modern banking system during the industrial revolution. The advent of this financial institution marked a significant improvement in social well-being, since banks provide several immaterial services and perform the crucial role of financial intermediaries between entrepreneurs and investors. By having illiquid assets and liabilities on their balance sheets, banks accept an element of vulnerability in order to provide those liquidity services that are essential for the continuity of productive investment. The other ‘social virtues’ of the banking system are its capacity to aggregate the savings of individual investors, allocate financial resources to the most productive activities, and restructure the duration and maturity of financial assets. A general limitation of this second stage of finance is that access to credit is restricted to individuals who have sufficient financial resources to provide collateral, the value of which must generally be at least equal to that of the amount borrowed. This restriction occurs because asymmetric information between lenders and borrowers prevents banks from efficiently performing their role of allocating financial resources to the most productive destinations. Asymmetric information is influential in three specific phases of the financing process: ex ante, when lenders cannot assess precisely the quality of the projects and entrepreneurs; in the interim, when lenders cannot constantly monitor the behaviour and effort of borrowers; and ex post, when borrowers may be tempted to default strategically in order to avoid paying back their loans. For all these reasons, the requirement of collateral as a guarantee for a loan is the shortcut that overcomes (Wydick 1999; Karlan 2005) the problems of informational asymmetries by reducing or eliminating bank losses in cases of non-performing loans. This solution, however, is a problem for those borrowers who remain without credit due to their lack of financial assets. The third stage of the financial system is the rise of MFIs, which were created precisely to address this problem. Empirical evidence demonstrates that these institutions are surprisingly successful in lending to uncollateralized borrowers without endangering their financial performance and actually have a proportion of non-performing loans that is lower than the average for the standard banking system (Armendáriz de Aghion and Morduch 2005). The reasons for this success are open to debate. Some scholars emphasize technical features of MFIs such as group lending with joint liability (Banerjee et al. 1994; Gangopadhyay et al. 2005), individual progressive loans (Wydick 1999; Karlan 2005), and individual loans with notional collateral. Other scholars point to organizational and immaterial elements, including systematic monitoring and training activity by loan officers, social sanctions that discourage delin-
quent behaviour by borrowers, and the capacity to trigger borrowers’ hidden resources such as promotion of their dignity and self-esteem.
