Access To Financial Services In Emerging Countries: How Are Lending Policies Fair?

Introduction

Financial markets and institutions exist to overcome the effects of information asymmetries and transaction costs that prevent the direct pooling and investment of society's savings. They mobilize savings and provide payments services that facilitate the exchange of goods and services. In addition, they produce and process information about investors and investment projects to guide the allocation of funds, monitor and govern investments, and help diversify, transform, and manage risk.1 When they work well they provide opportunities for all market participants to take advantage of the best investments by channeling funds to their most productive uses, hence boosting growth, improving income distribution, and reducing poverty. When they do not work well growth opportunities are missed, inequalities persist, and in extreme cases, there can be costly crises.

Until recently econometric research on the performance of formal financial systems around the world has focused mainly on their depth, efficiency, and stability. Cross-country regressions have shown financial depth to be not only pro-growth but also pro-poor: economies with better developed financial systems experience faster drops in income inequality and faster reductions in poverty levels. Much less attention has been devoted to financial outreach and inclusiveness: the extent to which individual firms and households can directly access formal financial services. Even deep financial systems may offer limited outreach. Yet important tasks of a well-functioning financial system are providing savings, payments, and risk-management products to as large a set of participants as possible and seeking out and financing any and all worthwhile growth opportunities. Without inclusive financial systems, poor individuals and small enterprises need to rely on their personal wealth or internal resources to invest in their education, become entrepreneurs, or take advantage of promising growth opportunities. It seems plausible, therefore, that an inclusive financial system might be associated not only with lower social and economic inequality, but also with a more dynamic economy as a whole (Rajan and Zingales 2003).

Modern development theories increasingly emphasize the key role of access to finance: lack of finance is often the critical mechanism for generating persistent income inequality, as well as slower economic growth. That is not to say that more borrowing by poor people or by highly leveraged enterprises is always a good thing. Abuses revealed in the United States sub-prime mortgage crisis of 2007-08 underline the danger of overborrowing, whether by individuals misled through predatory lenders or by over-optimistic entrepreneurs.

Earlier theories postulated that a rise in short-term inequality was an inevitable consequence of the early stages of economic development (Kuznets 1955, 1963). However, modern theory has examined the ways in which inequality can adversely affect growth prospects through limiting human capital accumulation and occupational choices, which implies that wealth redistribution can spur development (Banerjee and Newman 1993; Galor and Zeira 1993). Despite the emphasis that financial market imperfections receive in theory, development economists often take them as given and focus their attention on redistributive public policies to improve wealth distribution and to foster growth.2 However, financial market imperfections ...