Impact Evaluation of multilateral Development Policy under special consideration of Microcredits in the Federative Republic of Brazil

Bachelorarbeit von Carolin Cachovan

Introduction:

The worldwide reactions on humanitarian conflicts, global migration flows or terror attacks show that the violation of human rights in one part of the world also heavily affects the rest of the world. The world economy has passed through a variety of political and social crises recently which have enhanced a vigorous debate about the economic and political interdependencies of industrialized and developing countries. Major parts of the discussion have been the choice of adequate instruments to enhance development as well as the appropriate forms of development cooperation. Ever since the start of development policy in 1949 there has been skepticism about the effectiveness of development policy. Lately it has been criticized that the impoverished parts of the local population in developing countries are not able to participate in the design of the development process; therefore the combat of poverty is not as successful as is could be. In this context, new development programs and initiatives were established to foster the locals’ participation, promote sustainability and ensure well-operating financial systems. Microcredits are amongst those methods of development policy aiming to promote inclusive financial systems and poverty reduction.

Since the 1970s microcredits have become a popular instrument of multilateral development policy. In 2006 the Nobel Peace Prize was awarded to microcredit pioneer Muhammad Yunus to acknowledge his achievments in terms of poverty reduction and social development. Furthermore, the United Nations declared the year 2005 as the Year of Microcredit; in this context the UN tried to raise awareness of microcredits and emphasized the contribution of microcrediting to the achievement of the Millennium Development Goals.

Today microcredits are used in all parts of the world, but they especially reached outreach and scale in Asia and Latin America. Development policy has to encounter the challenge of how to integrate emerging countries successfully into the world economic order and to ensure a sustainable social and economic development. The strong population growth of emerging economic powers such as India, China or Brazil combined with urbanization and technological progress in the context of a globalized world will change the social structures and the world’s political balance in the twenty-first century.

Table of Content:

Text Sample:

Chapter 4, Microcredits:

4.1, Background and Functioning of Microcredits:

4.1.1, Definition and Objectives of Microcredits:

Establishing a sustainable inclusive financial system is of high importance to ensure economic growth and to fight poverty. However, typically formal banks associate the poor with high costs and risks due to lacking collateral. Therefore the poor often are denied access to credits and other financial services. However, microcredits enable the poor to use financial services without traditional collateral.

Microcredits became known due to their success in Asia and Latin America and they are defined as small loans of an average size of eighty USD. They aim to alleviate poverty and target to establish financial sustainability. Further objectives are the empowerment of women and the desire to interrupt the vicious circle of low income, low savings and low investments. Currently microcredits are predominantly used in developing nations, but they also find a market in emerging and industrialized countries. This thesis shall focus on the analysis of microcredits in developing and emerging nations.

The demand for microcredits in developing and emerging countries originates from ‘the unbanked’, describing the parts of society without access to formal financial services due to missing collateral. Major parts of microcredit customers are moderately poor, but the microcredit clients’ poverty levels range from very poor to vulnerable non-poor. Microcredit clients usually work in the informal sector and live in rural areas. Furthermore, they are mostly self-employed e.g. ‘small farmers (…) engaged in small income-generating activities like food processing’. Even if the initial microcredit approach was gender neutral now most of the customers are female. It has proved in this context that women spend more of their increased income on the household, the children’s education and the family welfare; moreover, they have better repayment rates than men.

Microcredits face a variety of challenges, e.g. they have to be sufficient in terms of scale and serve a large number of people. Secondly, they have to find ways to reach the very poor and geographically remote people which Helms describes as the challenge of depth. Lastly, microcredits have to be offered at the lowest possible costs.

In the following section the evolution of microcredits shall briefly be outlined.

4.1.2, Evolution of Microcredits:

Savings and credit groups have existed since 1700 when Jonathan Swift firstly initiated the Irish Loan Fund System. This loan fund provided loans (between ten and fifteen pounds) to poor farmers without demanding collateral. In 1800 Friedrich Wilhelm Raiffeisen created the concept of financial cooperatives of credit unions in Germany. Those cooperative banks (also called mutual savings banks) helped to build schools and made infrastructural improvements possible. The approach also found great acceptance in other European countries and finally also in the developing world. Raiffeisen’s goal was to ‘spread new group-based ways to provide financial services to the poor’. The actual microcredit movement started during the 1970s in Asia and Latin America with the first programs offering loans to poor women. However, the first microcredits during this time were allocated in the context of subsidized credit programs initiated by governments or international donor organizations. The start of the microcredit movement is often being referred to as the microcredit revolution and Helms describes it as the ‘introduction of credit methodologies that prove that poor people are bankable, can take loans and pay them back’. Microcredit pioneers were Acción International with programs in Brazil and other Latin American countries and the Grameen Bank in Bangladesh. The Grameen Bank was initiated by Mohammad Yunus as a project of the University of Chittagong, Bangladesh in 1976. Yunus established the Grameen Bank because the demand for capital and savings by major parts of society could not be met by regular financial institutions. In the initial phase of the Grameen Bank Yunus provided collateral-free microloans of thirty to forty-two USD for business activities like waving or making pots.

After the end of the cold war and the positive results of microcredits in Latin America and Asia the interest for microcredits as an instrument of development policy increased significantly. Especially the World Bank and other UN organizations recognized the importance of microcredits as a mean to fight poverty. In 1995 the World Bank established the Consultative Group to Assist the Poor with the goal to mobilize 200 billion USD for microcredits. During this time microcredit programs started to focus on cost recovery, achieving sustainability and reaching a larger number of clients. Furthermore, in the 1990s the term microcredit was expanded by the idea of microfinance. Microfinance not only includes credits for the poor, but also other financial services such as insurances, savings and capital transfer services. Before analyzing the operational design of microcredits, the theoretical background of credit markets and its impact on microcredits shall be explained. According to Simtowe imperfect information in credits markets causes adverse selection and moral hazard problems. He states that those information asymmetries as well as lacking physical collateral are the main reasons why credit markets for the poor fail.

4.2, Operating Principles of Microcredits:

4.2.1, Theoretical Background:

4.2.1.1, Principal-Agent-Theory:

Tschach states that ‘Information asymmetries make it difficult for banks to assess accurately whether (…) [borrowers] are able and / or willing to repay their loans’. In the context of credit markets ‘information asymmetries’ refer to the creditor not having any or only insufficient information about the borrower’s risk of default. Therefore creditors have to find ways to assess the borrower’s willingness and ability to re-pay the credit. This is one of the banking sector’s major challenges.

The principal agent theory (also called agency theory) analyzes situations in which information is asymmetrically distributed between two parties. Pratt and Zeckhauser explain an agency relationship as follows: ‘Whenever one individual depends on the action of another, an agency relationship arises. The individual taking the action is called the agent. The affected party is the principal’. In the context of microcredits the creditor is the principal and the borrower is the agent. Often the interests of the principal do not correspond with the interests of the agent and the agent frequently has an information advantage compared to the principal. This means the agent can improve his own benefit at the costs of the principal.

The agency theory focuses on designing relationships between principal and agent as well as on finding incentives to motivate the agent to act in the interest of the principal.In the context of microcredits two major information problems called adverse selection and moral hazard occur. Their relevance and possible solutions shall be assessed now, starting with the risk of adverse selection.