Insecurity and the death of rural credit markets (3)

I was in Enugu in the Southeastern part of Nigeria, over the weekend, to show be with a good friend whose daughter got married in the traditional way. Nigerians use their weekends in ways slightly different from their counterparts in Europe and America. We use the much of the time to settle share friendship. That, to us, is a great way to relax. For the average Nigerian male, a fun way to relax is to don the latest design of “Senator Caftan”, “agbada” or “babanriga” and head for a noisy (loud music) social event on weekends. I had one of those rousing times in the Coal City.

The event was peaceful because it was held in a serene village in the outskirts of the city. The music and traditional activities were soothing, though the peace interrupted was from time to time by blaring sound of siren, signaling the arrival of some of the many deities that run Nigeria, as they arrived.

Driving through the rich Independence Layout neighborhood, I had fun looking out of the window, turning my neck left and right. Before you think of bandits and insecurity, let me quickly say that it was not for any such fears. I was busy reading the messages advertised on every available space, including the walls of uncompleted buildings.

Read Also: Insecurity and the death of rural credit markets (2)

Evidently, I was in the bowls of one of the most enterprising people of Nigeria. Being a microenterprise enthusiast, I was making a mental note, and doing a pseudo-census of the many small businesses that boldly lifted their banners in advertisement contest with the big firms whose big banners stood tall on the roadsides. One advertisement hit me like a thunderbolt.

It is often the case that many small businesses fail to find lenders even when they are willing to pay very exorbitant rates. This seems to negate the well-established economic principle that a good price will call forth supply at any time.

This advertisement was hand-written and on the perimeter wall of an uncompleted building, beside which was hoisted the shouting message from a new generation bank, marshalling out its many services, including loans and advances. This advertisement read: “Stop and called us. We are the moneylender you are looking”.

This message was written in white paint, which dripped down as though to warn the potential borrower that a time of weeping and dripping of tears is not far ahead for anyone who respond to them.This set me thinking of the moneylender and why he continues to wax stronger, despite his obnoxious conduct and public policy aimed at displacing that kind of financial intermediation.

Stieglitz and Hoff had noted that the experience of most governments and institutional funding sources in the past several years is that “the moneylender not only refused to be displaced but became even more important in the informal credit markets”.

To support this view, we all know that interest rates charged by moneylenders have remained very high despite the many financial packages, which monetary authorities, like the Central Bank, have deployed to the informal sector operators. This is the evidenced that present institutional alternatives to the moneylender have not quite succeeded in their desire to displace him.

A paradigm shift is inevitable if we are to find answers to the problems and puzzles in the informal credit market, regarding the survival of the moneylender despite the high cost of its funds. In Economics, we learn that interest rates serve to allocate funds in the market. One of today’s imponderables is that interest rates no longer effectively deliver the service of an equilibrating mechanism they were known to be, in formal credit markets. It is often the case that many small businesses fail to find lenders even when they are willing to pay very exorbitant rates. This seems to negate the well-established economic principle that a good price will call forth supply at any time.

The failure of institutional intervention, lends support to the proposition that rural credit markets are significantly competitive in nature and that the high interest rate charged by the moneylender is a reflection of a the risk management capability of the informal credit markets.

Indeed, it reflects the fact that the lender factors into his analysis, the risk of non-payment by the borrower. This is very plausible, considering the dearth of information in that market. The lack of complete information in the rural credit market, otherwise known as information asymmetry, is fundamental to risk analysis and cost of funds in that market.

Essentially, the point being made is that due to the lack of information about borrowers and their undertakings, lenders place a premium on poor borrowers to compensate for the high risk of lending to them. This principle is of course applicable even in formal credit markets. Banks use pricing as an instrument of credit selection. They try to weed off very risky transaction by applying higher rates.

Another consequence of information asymmetry is what has been termed adverse selection – when lenders make loans to borrowers not on the grounds of business viability or ability to pay back but on their willingness to accept the very high interest rates applied as premium. Many such loans get lost though.