Content area
Full Text
ABSTRACT
The objective of the paper is to analyze the equilibrium in an economy where commercial banks/microfinance institutions can choose to provide downscaling/upscaling lending. I show that externalities are entrenched in the acquisition of the knowledge to provide either downscaling or upscaling lending. More importantly, downscaling lending dominates upscaling lending because it is only when the formal financial institutions venture into downscaling lending that the highest social welfare can be attained.
JEL Classification: G21; I30.
Key Words: Microcredit; Downscaling/upscaling Lending; Social Welfare; Entrenched Externality.
(ProQuest: ... denotes formulae omitted.)
1. INTRODUCTION
The building of an inclusive financial sector where commercial banks (referred to below as formal financial institutions (FFI)) and microfinance institutions (MFI) work together to offer appropriate microcredit to the unbankable and nearly-bankable is instrumental to a vibrant microfinance sector. This paper analyzes the equilibrium in an economy where commercial banks/microfinance institutions can choose to provide downscaling/upscaling lending. This objective is motivated by: 1) the general consensus among microfinance key players (CGAP, ACCION, UN, IFC, and USAID) that the development of new technologies has helped reduce transaction costs and make smaller transactions profitable; 2) the rising interest among private business in financial inclusion because of the growth and increasing purchasing power of the vast global market of low income earners (Rhyne, 2009); and 3) regulatory changes that have created conditions that allow commercial banks to extend credit to the unbankable and that allow microfinance institutions to provide financial services to the nearly- bankable.
The principal finding of the paper is that downscaling lending improves social welfare more effectively than upscaling lending does. This finding shows that for microfinance to achieve substantial poverty alleviation, which necessitates an outreach credit mechanism for the poor, commercial banks have to engage in microcredit. The combination of the outreach and the development of new technologies that lower the transaction costs of microcredit allows economies of scale, enabling the commercial banks to pursue their profit maximization objective. Further, an externality is embedded in the procurement of downscaling and upscaling lending. This finding is in line with the spillover effect entrenched in the relationship of two competing companies for the same market.
The rest of the paper is organized as follows. In section 2, I present stylized facts. In Section...