Institutional Moral Hazard and Inclusive Finance: When Good is Not so Good

12 Pages Posted: 21 Sep 2018

See all articles by Joy M. Kiiru

Joy M. Kiiru

University of Nairobi - Department of Economics

Date Written: July 30, 2018

Abstract

Moral hazard in financial institutions holds when either the institution or the client does not guard against risks either to themselves or for the other party mainly because they are protected from the consequences of such risk. Inclusive financial institutions that serve the poor are have cut a “polite and respectable image” and have therefore become the buzzword in development finance. There is, therefore, a dearth of information on inclusive lending methodologies like solidarity lending and their long terms effects on household welfare. It is within this background that this study was carried out. The study is motivated by a genre of empirical studies that have suggested the possibility of fuelling vulnerability to poverty among households by microfinance programs (Hulme and Mosley 1996, Morduch 2000, Kiiru 2007). The main objective of this paper is to articulate an alternative thesis that “informal collateral in the form of joint liability lending as currently implemented over-secures loans by poor borrowers thus exposing them further vulnerability to poverty”. We further argue that “over-insurance” of loans by poor borrowers is the main contributor to moral hazard by microfinance institutions. We intend to pursue this thesis theoretically and also empirically. The study, therefore, combines both parametric and non-parametric methods to document and track the process of access to credit by rural poor households, utilization of such credit across household expenditures both productive and nonproductive, repayment and the resulting welfare outcomes. The study demonstrates that without proper regulation and adherence to regulations, inclusive financial institutions could indeed result in a moral hazard. Moral hazard by financial institutions has adverse effects on household welfare.

Keywords: micro-finance institutions, Moral hazard, poor households, vulnerability to poverty

Suggested Citation

Kiiru, Joy M., Institutional Moral Hazard and Inclusive Finance: When Good is Not so Good (July 30, 2018). OIDA International Journal of Sustainable Development, Vol. 11, No. 03, pp. 23-34, 2018, Available at SSRN: https://ssrn.com/abstract=3248891

Joy M. Kiiru (Contact Author)

University of Nairobi - Department of Economics ( email )

Nairobi
Kenya

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