Improving Access to Credit

Faculty:Rema Hanna (Harvard Kennedy School)
Partnership between Harvard Kennedy School, Empowerment Lab, and IFMR Trust
Are the poor credit constrained? Would greater access to micro-credit in the poorest regions fuel development? Economic theory predicts that the rural poor have high returns to capital. Yet, many formal banking institutions do not enter poor, rural markets, due to the high transaction costs, risk, and the inability to screen for credit-worthiness.
Summary of Research
This research used two randomized experiments that examined how to improve access to financing for the rural poor in the Tumkur District of India.The first intervention offered various uncollateralized loan products with different conditions to the rural population, and collected data to understand both loan product design and the characteristics of individuals who take up the loan.The second intervention offered grants to the rural population, and obtained data by conducting a follow-up survey to understand the impact of the grant on consumption and general well-being.
The experiments allowed comparisons between high and low interest loans, as well as regular and more flexible payback plans. Researchers can assess what type of individuals take up particular loans and whether they are sensitive to loan conditions. In addition, the project uses baseline and repayment data to design credit scoring models that predict repayment, thereby reducing the risk of lending institutions entering rural markets. The study is one of the first to offer uncollateralized loans to an unscreened population, thus helping to gauge whether microfinance and banking institutions can be sustainable in traditional "high-risk" areas.
With first order results now in, findings suggest that higher interest rates discourage the poor from applying for loans.Thus, the notion that the poor are willing to borrow at high interest rates may not always be true. Researchers are analyzing the data to see what people spend the loans on and if the interest rate is related to how individuals spend the loan money.
Implications & Impacts
The project results have significant policy implications for the way banking institutions and microfinance institutions provide finance to the poor.If the poor have high returns to capital and limited access, then increasing access to credit markets will reduce poverty and promote growth. Reducing risk for lenders in rural markets may allow institutions to enter new markets. Further analysis will also assess whether grants, versus loans, result in different household outcomes. This will contribute to the policy debate regarding the best way to reduce poverty.
The project built a partnership with IFMR Trust, which provided the capital for the lending and has a network of microfinance branches reaching over 2 million families across India. IFMR Trust, a nonā€banking financial corporation venture, hopes to use the insights gained in this study to design products for the very poor.