Last week, we began a discussion of informal credit markets, particularly with regard to the impact of insecurity on the markets. To put that discussion in proper context, we shall step back a bit into the theoretical foundations of the market for those that found themselves surviving in the informal sector, so as to lay firm foundation for proper understanding of what is happening in that market and why.
To do this, we shall borrow copiously from my fairly well-received 2005 book, titled “Microfinance and Economic Activity: Breaking the Poverty Chain”. The section of it focusing on informal credit markets is still full of freshness that can help in this regard.
The preponderance of small businesses in both the rural and urban areas has led to the development of thriving markets that are significantly devoid of the trappings found in structured markets. Although credit markets are essentially divided into two – formal and informal markets, the dividing line is very thin.
In reality, the chain of credit suppliers is a spectrum or continuum that ranges from informal suppliers, such as landlords, landladies, suppliers, registered and unregistered finance companies, moneylenders, village meetings, “Esusu”, Revolving Savings and Credit Associations (ROSCAS), Accumulating Savings and Credit Associations (ASCAS), pawn brokers and traders who give credit to their customers, to formal institutions like deposit money banks and so on. Informal credit markets are the alternative sources of finance when formal sources are not available.
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These markets display characteristics that give them their comparative advantage in terms of speed of delivery and operational cost reduction, though they are not known to share the benefits of these advantages with their clients. Their core features include informality, adaptability and flexibility of operations.
They operate mostly in specialised market segments, making small-sized loans and operating below the radar of the regulatory authorities. Loans are based more of familiarity than collateral. Social sanction takes the place of legal enforcement.
The same lack of information prevents the borrower from finding alternative lenders at cheaper rates in this market, where the moneylender is ripping off his clients
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Information is scarce. It is this information scarcity that causes much of the distortions in informal credit markets. They are patronised mainly by individuals and small and micro enterprises that lack alternative sources of funds. Lack of credit information makes many lenders shy away from small businesses operating in the informal sector, or to place very high-risk premiums on their loans.
The same lack of information prevents the borrower from finding alternative lenders at cheaper rates in this market, where the moneylender is ripping off his clients. This is the basis of the issues of information asymmetry, adverse selection and moral hazard, which play key roles in this market.
Perhaps, the risk perception of lenders and, by extension, the risk premium paid by small borrowers, would be reduced if lenders had access to adequate information on borrowers and the borrowers are aware of alternative sources of funds.
Unfortunately, this is not happening. There are many misconceptions about the poor, their credit behaviour as well as the businesses they run. A lot would be gained if some of the negative notions or myths surrounding the poor, which have compounded their plight, are dismissed through improved knowledge. Many people do not know that poverty does not automatically imply lack of integrity among the poor. There is abundant evidence that the poor, who lack influence and access to the instruments of coercion, are more trustworthy than the rich.
In trying to establish the impact of insecurity on informal credit markets in Nigeria, we shall give some insight to the nature of financial markets patronized mostly by the poor, drawing considerably from the work of Hoff and Stigliz done in the 1990s.
Hoff and Stiglitz examined these markets within the framework of imperfect information paradigm, which posits that the conduct of moneylenders reflects the fact that they have total control of the market, hence they are brash, arrogant and brutal.
In most cases, they exercise monopoly powers. They are not afraid of competition or loss of market share. This has led many to think that rural credit markets are imperfect or simply monopolistic, a view to which Hoff and Stiglitz did not subscribe.
Many authorities agree that the high-interest rate charged by moneylenders is due to the shortage of funds in that market. In other words, the interplay of demand and supply forces determines the price of funds, otherwise called interest rate. This price must be high enough to compensate for scarcity and risk. This is the situation faced by borrowers before the introduction of rampant insecurity in Nigeria, a situation that has compounded this plight.
