Opinion : The economics of microcredit
Thursday, January 2, 2014
A formal bank generally comes to the poor and rural areas from the outside. It lacks the information about the local borrower, the quality of his product or his general reputation in the community. Contrary to a formal bank having head offices in a big city, the local informal lenders live in the community and have the essential information about the borrowers.
Due to asymmetric information, the bank is unable to accurately assess the riskiness of the borrower’s project. The financial institutions either charge very high interest rates or do credit rationing to overcome the problem of adverse selection and hardly allocate any credit to the very poor.