An Introduction to Microcredit: Why Money is Flowing from the Rich to the Poor

Abstract

The paper examines why capital didn't flow from the rich to the poor. The problems identified are categorized in three broad categories: lack of complementary human capital, information asymmetries and transaction costs for small loan sizes. It explains how moneylenders solve the information asymmetry problems. It then shows that recently, microcredit has taken the world by storm. This development has considerably impacted economies at the grass root levels. The paper therefore examines how Microfinance institutions have overcome the obstacles to mobility of capital, notably those relating to information asymmetry and transaction costs, but also, in some cases, those related to complementary human capital. The reduction in information asymmetry by Microfinance institutions is not done in the same way as by moneylenders. Finally, the paper explains how these microfinance institutions obtain financing to understand why their costs are lower than those of moneylenders.

A considerably advanced & modified version of this paper has been accepted for publication in the Journal of Economic Issues (forthcoming September 2009) under the title "Microcredit capital flows and interest rates: An Alternative Explanation"

Keywords: Microfinance, poverty, moneylender, information asymmetry, adverse selection, moral hazard, transaction costs

JEL Classification: D00, D10, D2, D4, D8, E22, E31, E41, E43, E5, F2