1 00:00:00,040 --> 00:00:02,460 The following content is provided under a Creative 2 00:00:02,460 --> 00:00:03,970 Commons license. 3 00:00:03,970 --> 00:00:06,910 Your support will help MIT OpenCourseWare continue to 4 00:00:06,910 --> 00:00:08,700 offer high quality, educational 5 00:00:08,700 --> 00:00:10,660 resources for free. 6 00:00:10,660 --> 00:00:13,460 To make a donation or view additional materials from 7 00:00:13,460 --> 00:00:17,390 hundreds of MIT courses, visit MIT OpenCourseWare at 8 00:00:17,390 --> 00:00:18,640 ocw.mit.edu. 9 00:00:25,936 --> 00:00:31,470 PROFESSOR: A lot of what we have done, until today, we 10 00:00:31,470 --> 00:00:40,840 sort of assumed, at one place or another, that the people 11 00:00:40,840 --> 00:00:42,640 were unable to borrow. 12 00:00:42,640 --> 00:00:45,230 For example, a lot of the s-shaped problem that we have 13 00:00:45,230 --> 00:00:48,710 seen along the way, people would be able to escape from 14 00:00:48,710 --> 00:00:50,850 them if only they could borrow. 15 00:00:50,850 --> 00:00:53,740 For example, all of the issues on risk that we've discussed, 16 00:00:53,740 --> 00:00:58,220 that people have these shocks and they lose their business. 17 00:00:58,220 --> 00:01:01,170 And that puts them back on the left part of the curve. 18 00:01:01,170 --> 00:01:06,080 This could be removed if you were able to borrow your way 19 00:01:06,080 --> 00:01:07,890 out of these problems. 20 00:01:07,890 --> 00:01:09,700 So when you are in a bad shock, you borrow. 21 00:01:09,700 --> 00:01:12,180 And when you are in good state, you reimburse, and 22 00:01:12,180 --> 00:01:13,430 everything is good. 23 00:01:16,590 --> 00:01:22,790 So it seems that we needed to spend some time discussing. 24 00:01:22,790 --> 00:01:24,190 We can't really take it as given that 25 00:01:24,190 --> 00:01:26,090 people can't borrow. 26 00:01:26,090 --> 00:01:27,490 First, because it's not true, actually. 27 00:01:27,490 --> 00:01:29,300 Poor people borrow a lot. 28 00:01:29,300 --> 00:01:30,900 It depends, a bit, from country to country. 29 00:01:30,900 --> 00:01:34,270 But in a country like India, for example, about 70% of 30 00:01:34,270 --> 00:01:37,530 people will have some loan from someone, usually not from 31 00:01:37,530 --> 00:01:42,330 a bank, but from a moneylender or a shopkeeper or their 32 00:01:42,330 --> 00:01:44,210 landlord or something like that. 33 00:01:44,210 --> 00:01:47,180 So there are actually a lot of lending-borrowing 34 00:01:47,180 --> 00:01:49,030 relationships around. 35 00:01:49,030 --> 00:01:51,500 So it doesn't seem to be a very good assumption to start 36 00:01:51,500 --> 00:01:53,830 with the idea that people can't borrow. 37 00:01:53,830 --> 00:01:56,810 Secondly is, even if they couldn't borrow, we want to 38 00:01:56,810 --> 00:01:58,740 spend some time and try to understand 39 00:01:58,740 --> 00:02:00,490 why that's the case. 40 00:02:00,490 --> 00:02:06,660 So in a sense, we could have done this many lectures ago. 41 00:02:06,660 --> 00:02:12,360 But finally, we are now getting the crux of this 42 00:02:12,360 --> 00:02:15,610 borrowing question. 43 00:02:15,610 --> 00:02:21,070 What the newspaper article, for today, made kind of clear 44 00:02:21,070 --> 00:02:25,970 is that this is one way, one reason why you should be 45 00:02:25,970 --> 00:02:28,320 interested in these things or you might be interested in 46 00:02:28,320 --> 00:02:29,570 this things. 47 00:02:33,490 --> 00:02:39,040 Microcredit is being discussed a lot these days. 48 00:02:39,040 --> 00:02:43,190 Has anyone heard what is happening to Yunus these days? 49 00:02:43,190 --> 00:02:46,075 Have any of you heard like what's the situation? 50 00:02:50,550 --> 00:02:50,916 Sorry? 51 00:02:50,916 --> 00:02:51,850 AUDIENCE: Did you say, Yunus? 52 00:02:51,850 --> 00:02:52,450 PROFESSOR: Yunus, yeah. 53 00:02:52,450 --> 00:02:53,856 What's happening with Yunus? 54 00:02:53,856 --> 00:02:56,172 AUDIENCE: I don't know the details, but he's kind of 55 00:02:56,172 --> 00:02:58,587 getting pushed out of the organization that he started, 56 00:02:58,587 --> 00:03:02,460 Grameen, the microfinance banking [INAUDIBLE]. 57 00:03:02,460 --> 00:03:05,750 PROFESSOR: Right, so he's being pushed out of Grameen on 58 00:03:05,750 --> 00:03:06,700 sort of technical reasons. 59 00:03:06,700 --> 00:03:07,540 I mean it's not. 60 00:03:07,540 --> 00:03:09,540 He is older than 70. 61 00:03:09,540 --> 00:03:12,170 And then the government is arguing that Grameen is a 62 00:03:12,170 --> 00:03:16,320 public bank, because the state owns some 63 00:03:16,320 --> 00:03:17,370 parts of the capital. 64 00:03:17,370 --> 00:03:19,120 But a very small part, because Grameen is 65 00:03:19,120 --> 00:03:21,446 largely held by the borrowers. 66 00:03:21,446 --> 00:03:23,700 They're now trying to push him out. 67 00:03:23,700 --> 00:03:25,940 And at the same time, there is a discourse along the line 68 00:03:25,940 --> 00:03:29,030 that, ooh, maybe microcredit is not all that its cracked up 69 00:03:29,030 --> 00:03:31,010 to be, et cetera. 70 00:03:31,010 --> 00:03:40,870 This follows a big event in India, in November, where, in 71 00:03:40,870 --> 00:03:44,980 Andhra Pradesh, one of the hot beds of microfinance in India, 72 00:03:44,980 --> 00:03:48,730 the government decided that it was now illegal to-- 73 00:03:48,730 --> 00:03:51,440 issued and ordinance saying that it was illegal to ask 74 00:03:51,440 --> 00:03:56,210 people to repay in the absence of the local mayor. 75 00:03:56,210 --> 00:04:01,120 So given that the local mayor are not always in the field, 76 00:04:01,120 --> 00:04:04,120 always present, et cetera, that turns out to be a pretty 77 00:04:04,120 --> 00:04:05,420 big constraint. 78 00:04:05,420 --> 00:04:08,590 So all the repayments stopped to microfinance agencies in 79 00:04:08,590 --> 00:04:09,710 Andhra Pradesh, in November. 80 00:04:09,710 --> 00:04:12,460 And to this day, they haven't really restarted. 81 00:04:12,460 --> 00:04:15,320 And in the context of that, you have had a lot of articles 82 00:04:15,320 --> 00:04:19,149 in the press about maybe microcredit is actually bad, 83 00:04:19,149 --> 00:04:21,300 maybe microcredit is the new usury. 84 00:04:21,300 --> 00:04:23,980 But I don't want to go into the details of whether it's 85 00:04:23,980 --> 00:04:28,380 good or bad now, because you're going to do it in the 86 00:04:28,380 --> 00:04:30,140 next lecture. 87 00:04:30,140 --> 00:04:33,500 What I want to do is to give us some tools, today. 88 00:04:33,500 --> 00:04:36,350 So it's going to be a little bit more theoretical lecture 89 00:04:36,350 --> 00:04:37,460 than usually. 90 00:04:37,460 --> 00:04:42,920 I want to give us some tools to try to understand why it 91 00:04:42,920 --> 00:04:46,300 might be difficult for the poor to borrow, why the poor 92 00:04:46,300 --> 00:04:51,460 might face higher interest rates, and what microcredit 93 00:04:51,460 --> 00:04:55,750 has done that can partially solve this program or why it 94 00:04:55,750 --> 00:04:57,460 doesn't solve them fully, et cetera. 95 00:04:57,460 --> 00:05:01,282 That's kind of where we're heading, now. 96 00:05:01,282 --> 00:05:04,770 So maybe we can start with some facts that it's good to 97 00:05:04,770 --> 00:05:05,550 have in mind. 98 00:05:05,550 --> 00:05:08,820 And then we are going to have a series of simple models that 99 00:05:08,820 --> 00:05:10,790 we are going to try to apply to these facts. 100 00:05:13,290 --> 00:05:17,730 So the first fact is that most of the poor do not have access 101 00:05:17,730 --> 00:05:23,690 to any kind of formal credit, excluding microfinance, which 102 00:05:23,690 --> 00:05:27,150 reaches about 200 million people worldwide. 103 00:05:27,150 --> 00:05:31,480 So most of the poor don't borrow from a bank or from a 104 00:05:31,480 --> 00:05:34,010 credit union or something like that. 105 00:05:34,010 --> 00:05:37,360 There are some numbers that are coming from the the data 106 00:05:37,360 --> 00:05:40,520 set on the life of the poor, under $1 a day. 107 00:05:40,520 --> 00:05:42,470 You see, on the left side, the fraction of 108 00:05:42,470 --> 00:05:43,480 people who have a loan. 109 00:05:43,480 --> 00:05:46,570 And you see that it's not nothing. 110 00:05:46,570 --> 00:05:51,110 Actually, the number six is wrong. 111 00:05:51,110 --> 00:05:51,520 It's more. 112 00:05:51,520 --> 00:05:57,350 60% of people had a loan in India, Cote d'Ivoire, 31%, 12% 113 00:05:57,350 --> 00:06:00,375 in Indonesia, 93% in Pakistan. 114 00:06:00,375 --> 00:06:00,710 Yeah? 115 00:06:00,710 --> 00:06:03,410 AUDIENCE: Why is there is such a big discrepancy between-- 116 00:06:03,410 --> 00:06:04,770 or why [INAUDIBLE] 117 00:06:04,770 --> 00:06:08,260 informal market in Pakistan? 118 00:06:08,260 --> 00:06:11,275 PROFESSOR: So first, what you notice is that 119 00:06:11,275 --> 00:06:13,780 everywhere you have. 120 00:06:13,780 --> 00:06:16,840 The fact that a lot of the loans that people. 121 00:06:16,840 --> 00:06:19,070 So there are two facts in this corner-- or three facts. 122 00:06:19,070 --> 00:06:22,460 One is that it is not that credit access is 0 in most 123 00:06:22,460 --> 00:06:26,110 countries, except in Panama, where it's pretty low. 124 00:06:26,110 --> 00:06:30,130 The second fact is maybe what you were talking about, that 125 00:06:30,130 --> 00:06:33,220 there is a lot of viability, where in a place like Pakistan 126 00:06:33,220 --> 00:06:36,000 or India-- once the typo is corrected-- 127 00:06:36,000 --> 00:06:41,130 you have an enormous amount of lending, like 93% of people 128 00:06:41,130 --> 00:06:42,830 have a loan. 129 00:06:42,830 --> 00:06:46,000 And the third fact is that these loans are mostly not 130 00:06:46,000 --> 00:06:50,330 from the formal sector, with the possible exception of 131 00:06:50,330 --> 00:06:57,520 Indonesia, that has 25% of loans coming 132 00:06:57,520 --> 00:06:58,980 from the formal sector. 133 00:06:58,980 --> 00:07:00,660 Do you want to re-ask your question to make sure then? 134 00:07:00,660 --> 00:07:03,436 AUDIENCE: Yeah, I mean, just Pakistan has such percentage 135 00:07:03,436 --> 00:07:05,121 of individual with loans. 136 00:07:05,121 --> 00:07:09,504 I mean it would be more understandable that fraction 137 00:07:09,504 --> 00:07:11,939 of loans coming from a bank in a country that doesn't have 138 00:07:11,939 --> 00:07:13,400 that much lending would be lower, just because there 139 00:07:13,400 --> 00:07:14,390 isn't that much opportunity. 140 00:07:14,390 --> 00:07:17,324 What surprises me is how low the fraction of loans that are 141 00:07:17,324 --> 00:07:19,565 coming from a bank, given how many individuals 142 00:07:19,565 --> 00:07:20,810 have loans at all. 143 00:07:20,810 --> 00:07:23,798 So I was wondering if there is a reason that that's the case 144 00:07:23,798 --> 00:07:26,860 in Pakistan or is it an anomaly? 145 00:07:26,860 --> 00:07:28,500 PROFESSOR: So in a sense, we could ask the 146 00:07:28,500 --> 00:07:30,710 question two ways. 147 00:07:30,710 --> 00:07:34,480 Why is the informal loan market so particularly active 148 00:07:34,480 --> 00:07:35,830 in Pakistan? 149 00:07:35,830 --> 00:07:39,920 Or why is the formal market so absent? 150 00:07:39,920 --> 00:07:42,230 And I think the first question, in a sense, is the 151 00:07:42,230 --> 00:07:43,790 way to ask it. 152 00:07:43,790 --> 00:07:46,730 Basically, in Pakistan, there is not much more formal 153 00:07:46,730 --> 00:07:53,080 lending then in a place like, say, Cote d'Ivoire. 154 00:07:53,080 --> 00:07:57,620 But there is much more informal lending, so there is 155 00:07:57,620 --> 00:07:58,420 much more activity. 156 00:07:58,420 --> 00:07:59,820 That varies a lot. 157 00:07:59,820 --> 00:08:01,520 That varies from country to country. 158 00:08:01,520 --> 00:08:04,480 Within countries, it also varies from place to place. 159 00:08:04,480 --> 00:08:10,120 And it also varies even within a village, within a region. 160 00:08:10,120 --> 00:08:12,710 Who has access to credit, who doesn't have access to credit 161 00:08:12,710 --> 00:08:14,080 also varies. 162 00:08:14,080 --> 00:08:18,000 So I can't really answer the question, right now. 163 00:08:18,000 --> 00:08:20,270 But I'm sort of hoping that, by the end of the lecture, 164 00:08:20,270 --> 00:08:23,520 we'll have some elements that we can apply back to saying, 165 00:08:23,520 --> 00:08:25,252 why are things different in Pakistan ? 166 00:08:25,252 --> 00:08:25,590 Yeah? 167 00:08:25,590 --> 00:08:28,824 AUDIENCE: What's the percent of people with a loan 168 00:08:28,824 --> 00:08:30,680 [INAUDIBLE] in developed countries? 169 00:08:30,680 --> 00:08:32,434 PROFESSOR: What's the percentage of people with a 170 00:08:32,434 --> 00:08:33,760 loan in developed countries? 171 00:08:33,760 --> 00:08:36,059 I think it would be very, very, very high. 172 00:08:36,059 --> 00:08:40,010 Because, as soon as you have a credit card, you have a loan. 173 00:08:40,010 --> 00:08:43,230 So I think, as a fraction of adults, that it would be 174 00:08:43,230 --> 00:08:45,210 pretty close to one, I would say. 175 00:08:49,070 --> 00:08:50,330 You're absolutely right. 176 00:08:50,330 --> 00:08:51,630 I don't know if this is what you had in mind. 177 00:08:51,630 --> 00:08:55,840 But this is lower than in developed countries. 178 00:08:55,840 --> 00:09:00,210 And what is particularly striking is the low access to 179 00:09:00,210 --> 00:09:03,875 any kind of formal lending. 180 00:09:03,875 --> 00:09:06,845 AUDIENCE: How would it look different if it was urban 181 00:09:06,845 --> 00:09:07,835 instead of rural households? 182 00:09:07,835 --> 00:09:09,815 Because like Panama is really weird. 183 00:09:09,815 --> 00:09:11,810 It must be [INAUDIBLE]. 184 00:09:11,810 --> 00:09:13,060 PROFESSOR: Few people living [INAUDIBLE]. 185 00:09:15,620 --> 00:09:19,350 In the same table, we also have the urban households. 186 00:09:19,350 --> 00:09:25,140 They will have more loans and more informal loans. 187 00:09:25,140 --> 00:09:29,710 So the ratio of informal to formal in urban households is 188 00:09:29,710 --> 00:09:32,410 actually not that different from what it is here. 189 00:09:32,410 --> 00:09:35,150 You have more loans and more informal loans and more formal 190 00:09:35,150 --> 00:09:37,000 loans, with a ratio-- 191 00:09:37,000 --> 00:09:37,670 to my knowledge-- 192 00:09:37,670 --> 00:09:40,590 remaining more or less constant. 193 00:09:40,590 --> 00:09:44,930 That's the first fact, a fair amount of loans but very few 194 00:09:44,930 --> 00:09:47,780 formal loans. 195 00:09:47,780 --> 00:09:52,030 The second fact is more like a history fact. 196 00:09:52,030 --> 00:09:53,880 Governments have tried, historically, to do 197 00:09:53,880 --> 00:09:55,680 something about it. 198 00:09:55,680 --> 00:10:01,000 So in the 1960s and the 1970s, many governments of developing 199 00:10:01,000 --> 00:10:07,540 countries, in India, in Brazil, in Colombia, in Peru, 200 00:10:07,540 --> 00:10:14,660 in Mexico tried to either force or subsidize the banks, 201 00:10:14,660 --> 00:10:19,650 either public banks or government banks, to go and 202 00:10:19,650 --> 00:10:21,150 lend to the poor. 203 00:10:21,150 --> 00:10:25,400 So in India, for example, the way it happened is, first, the 204 00:10:25,400 --> 00:10:29,700 banks were nationalized, by Mrs. Gandhi, during the same 205 00:10:29,700 --> 00:10:30,625 period as The Emergency. 206 00:10:30,625 --> 00:10:33,470 They were nationalized in two waves. 207 00:10:33,470 --> 00:10:36,780 And then the banks, irrespective of whether they 208 00:10:36,780 --> 00:10:40,580 were nationalized or not, were then told that they could not 209 00:10:40,580 --> 00:10:45,390 open a branch in a town if they did not open, at the same 210 00:10:45,390 --> 00:10:48,730 time, four branches in rural areas that were 211 00:10:48,730 --> 00:10:50,430 not previously served. 212 00:10:50,430 --> 00:10:53,900 So as the bank tried to expand in an urban area, where they 213 00:10:53,900 --> 00:10:58,250 had a market, they had to expand in rural areas. 214 00:10:58,250 --> 00:11:03,810 And moreover, to this day, banks were given rules about 215 00:11:03,810 --> 00:11:07,190 how their portfolio needed to be allocated. 216 00:11:07,190 --> 00:11:11,350 So you have a rule called a priority sector rule, saying 217 00:11:11,350 --> 00:11:15,600 that the bank must lend 40% of their portfolio to the 218 00:11:15,600 --> 00:11:17,260 priority sector. 219 00:11:17,260 --> 00:11:19,040 The priority sector is small enterprises 220 00:11:19,040 --> 00:11:20,420 in the rural sector. 221 00:11:20,420 --> 00:11:23,180 And within priority sector, they need to do at least a 222 00:11:23,180 --> 00:11:25,190 fraction to the rural sector. 223 00:11:25,190 --> 00:11:27,510 So both of these things are forcing the banks to go into 224 00:11:27,510 --> 00:11:31,610 the rural areas and then forcing them to balance their 225 00:11:31,610 --> 00:11:35,900 portfolio this way and capping the interest rate up, capping 226 00:11:35,900 --> 00:11:37,670 the interest rate that they could charge. 227 00:11:37,670 --> 00:11:41,350 It had the result that loans were pushed to farmers and 228 00:11:41,350 --> 00:11:42,860 things like that. 229 00:11:42,860 --> 00:11:48,640 But those loans were rather a disaster, with very, very high 230 00:11:48,640 --> 00:11:49,910 default rates. 231 00:11:49,910 --> 00:11:52,120 So a lot of people never reimbursed their loans. 232 00:11:52,120 --> 00:11:54,930 And eventually, they became more like a political giveaway 233 00:11:54,930 --> 00:11:56,980 rather than a credit program. 234 00:11:56,980 --> 00:12:00,020 So it became sort of expensive, inefficient way to 235 00:12:00,020 --> 00:12:04,420 give people money as opposed to a real credit program. 236 00:12:04,420 --> 00:12:06,570 Let's give you one illustration of a political 237 00:12:06,570 --> 00:12:11,650 giveaway, which is a paper by Shawn Cole, which looks at 238 00:12:11,650 --> 00:12:14,050 what he calls lending cycle. 239 00:12:14,050 --> 00:12:16,970 You're missing something important, which is what is on 240 00:12:16,970 --> 00:12:21,900 the x-axis, over here, is the year until the next election. 241 00:12:21,900 --> 00:12:23,952 So this is the year. 242 00:12:23,952 --> 00:12:26,460 There is an election about every five years. 243 00:12:26,460 --> 00:12:27,870 So this is saying this is the year just 244 00:12:27,870 --> 00:12:30,730 before the next election. 245 00:12:30,730 --> 00:12:34,280 And what you're seeing is that the year before an election, 246 00:12:34,280 --> 00:12:37,780 you get a huge boost in lending, suddenly. 247 00:12:37,780 --> 00:12:40,050 And this is for public banks. 248 00:12:40,050 --> 00:12:42,550 And if we look at private banks-- there are a few left-- 249 00:12:42,550 --> 00:12:45,830 you don't have these political lending cycle. 250 00:12:45,830 --> 00:12:48,410 And another thing that he has, which is interesting, is that 251 00:12:48,410 --> 00:12:51,940 you get more of this boost in swing districts, in districts 252 00:12:51,940 --> 00:12:54,670 that are where the margin of victory in the previous 253 00:12:54,670 --> 00:12:59,980 election was low, then in safe districts, where it's pretty 254 00:12:59,980 --> 00:13:01,845 clear who was going to win the election. 255 00:13:01,845 --> 00:13:02,180 Yeah? 256 00:13:02,180 --> 00:13:03,380 AUDIENCE: I might have missed it. 257 00:13:03,380 --> 00:13:06,321 So why is there more lending before an election? 258 00:13:06,321 --> 00:13:09,123 Is that because after the person gets elected, everyone 259 00:13:09,123 --> 00:13:10,060 just defaults [INAUDIBLE]? 260 00:13:10,060 --> 00:13:13,590 PROFESSOR: So remember all of the facts that I just said. 261 00:13:13,590 --> 00:13:16,090 You get more lending just before the election. 262 00:13:16,090 --> 00:13:17,450 It's only public banks. 263 00:13:17,450 --> 00:13:20,280 And it's only in swing districts, in districts where 264 00:13:20,280 --> 00:13:23,010 the margin of victory in the previous election was close. 265 00:13:23,010 --> 00:13:25,212 So why do they lend more? 266 00:13:25,212 --> 00:13:27,180 AUDIENCE: They borrow [INAUDIBLE], because the 267 00:13:27,180 --> 00:13:29,640 candidates will make a promise that they'll [INAUDIBLE] 268 00:13:29,640 --> 00:13:32,600 don't have to pay [INAUDIBLE]. 269 00:13:32,600 --> 00:13:34,720 PROFESSOR: Exactly. 270 00:13:34,720 --> 00:13:36,160 The default rate is so high that loans 271 00:13:36,160 --> 00:13:39,675 are pretty much gifts. 272 00:13:39,675 --> 00:13:43,105 So if you give more of it, than it's like vote buying 273 00:13:43,105 --> 00:13:45,180 kind of activities. 274 00:13:45,180 --> 00:13:45,620 Yeah? 275 00:13:45,620 --> 00:13:46,500 AUDIENCE: Could you go back to the 276 00:13:46,500 --> 00:13:48,320 previous slide for a second? 277 00:13:48,320 --> 00:13:51,940 Why is it 0, negative 0.1, negative 0.2? 278 00:13:51,940 --> 00:13:55,415 PROFESSOR: So 0 is just a normalization. 279 00:13:55,415 --> 00:13:56,755 So it starts at 0. 280 00:13:56,755 --> 00:13:58,940 It is saying that any year that is not a year just before 281 00:13:58,940 --> 00:14:02,560 the election is below. 282 00:14:02,560 --> 00:14:06,620 Because this is to show, in relation to that year, the old 283 00:14:06,620 --> 00:14:07,320 one is negative. 284 00:14:07,320 --> 00:14:09,705 An you have the little standard errors on 285 00:14:09,705 --> 00:14:11,660 the side, as well. 286 00:14:11,660 --> 00:14:13,330 Good question. 287 00:14:13,330 --> 00:14:17,540 Whatever the level is, he's normalized them. 288 00:14:17,540 --> 00:14:20,850 So basically, that is telling you that even 289 00:14:20,850 --> 00:14:22,180 if you had the effort. 290 00:14:22,180 --> 00:14:24,190 It's not that Grameen's didn't try. 291 00:14:24,190 --> 00:14:25,870 But in India-- 292 00:14:25,870 --> 00:14:28,340 and then it's also the case in other countries-- 293 00:14:28,340 --> 00:14:32,290 eventually, they stopped trying to at least use these 294 00:14:32,290 --> 00:14:34,170 banks as banks. 295 00:14:34,170 --> 00:14:36,410 They are more used as like pushing money away. 296 00:14:36,410 --> 00:14:39,240 Eventually, in India, they decided to shut down the 297 00:14:39,240 --> 00:14:42,750 social banking program in the early 1990s. 298 00:14:42,750 --> 00:14:46,600 Now the banks that don't have to start in rural areas. 299 00:14:46,600 --> 00:14:48,940 They still have the priority sector rules, but they don't 300 00:14:48,940 --> 00:14:51,290 have to start in rural areas. 301 00:14:51,290 --> 00:14:57,650 So that's the fast fact of two halves of a fact, very little 302 00:14:57,650 --> 00:15:06,420 formal lending and rather not very good performances in the 303 00:15:06,420 --> 00:15:09,620 effort to lend to the poor. 304 00:15:09,620 --> 00:15:14,730 The second fact, so people, when they access loans, access 305 00:15:14,730 --> 00:15:18,230 them mostly from the informal sector. 306 00:15:18,230 --> 00:15:22,180 And the second fact that is important is that loans are 307 00:15:22,180 --> 00:15:24,570 available in the informal sector, but the interest rates 308 00:15:24,570 --> 00:15:29,770 are very high, very high and very variable, which is going 309 00:15:29,770 --> 00:15:31,330 to be our next fact. 310 00:15:31,330 --> 00:15:36,140 But just to say very high, the sort of range where I think 311 00:15:36,140 --> 00:15:40,620 you would get most of the rates is between 40% a year to 312 00:15:40,620 --> 00:15:42,670 200% a year. 313 00:15:42,670 --> 00:15:48,400 That's pretty high, if you compare very, very high 314 00:15:48,400 --> 00:15:51,130 interest rates on your credit card, in the US, is of the 315 00:15:51,130 --> 00:15:52,710 order of maybe 20% a year. 316 00:15:52,710 --> 00:15:53,510 Yeah? 317 00:15:53,510 --> 00:15:55,040 AUDIENCE: So a question I had while reading the article was, 318 00:15:55,040 --> 00:15:56,984 yes, they're very high, percentage-wise. 319 00:15:56,984 --> 00:16:01,170 But if the loan amounts are so small, like, say, if I were to 320 00:16:01,170 --> 00:16:03,630 borrow $1 today, I have to pay $2 tomorrow. 321 00:16:03,630 --> 00:16:06,525 That's a huge percent increase, but it's not that 322 00:16:06,525 --> 00:16:08,640 big of an amount. 323 00:16:08,640 --> 00:16:11,197 PROFESSOR: It's not that big of an amount but from your 324 00:16:11,197 --> 00:16:12,510 perspective. 325 00:16:12,510 --> 00:16:14,770 It's a very good point. 326 00:16:14,770 --> 00:16:17,480 And we're going to go back to that, which is the fact that 327 00:16:17,480 --> 00:16:22,190 it's not that big of an amount is relevant for the bank, who 328 00:16:22,190 --> 00:16:24,355 is giving you this money. 329 00:16:24,355 --> 00:16:26,930 But for you, it just means that whatever-- 330 00:16:26,930 --> 00:16:29,520 it's still, the interest rate is very high. 331 00:16:29,520 --> 00:16:33,470 So unless you have a very good use for this money, the fact 332 00:16:33,470 --> 00:16:36,470 that it's just $1, yet you have somehow to find a way to 333 00:16:36,470 --> 00:16:38,900 transform this $1 into $2 next year. 334 00:16:42,370 --> 00:16:43,800 We're going to go back to your point. 335 00:16:43,800 --> 00:16:45,340 From the point of view of supply, it's 336 00:16:45,340 --> 00:16:46,910 going to matter a lot. 337 00:16:46,910 --> 00:16:47,590 You're going to see that. 338 00:16:47,590 --> 00:16:49,970 It's going to turn out to be one of the key things, which 339 00:16:49,970 --> 00:16:53,230 is, because people borrow a lot, these high interest rates 340 00:16:53,230 --> 00:16:56,090 are, in a month, a relatively small part. 341 00:16:56,090 --> 00:16:59,370 But from the point of view of the borrower, it means that, 342 00:16:59,370 --> 00:17:02,130 not only they can't borrow much, but they have to repay 343 00:17:02,130 --> 00:17:04,349 this huge interest rate. 344 00:17:04,349 --> 00:17:06,440 It comes to the daily rate. 345 00:17:06,440 --> 00:17:08,520 Some people borrow on the daily market. 346 00:17:08,520 --> 00:17:13,260 For example, food vendors borrow on the daily market. 347 00:17:13,260 --> 00:17:17,839 A common rate on the daily market is 5% a day. 348 00:17:17,839 --> 00:17:21,740 So do you have like a guess of what 5% a day is per year? 349 00:17:25,150 --> 00:17:26,887 An order of magnitude? 350 00:17:32,700 --> 00:17:35,870 Is it 5% multiplied by 365? 351 00:17:35,870 --> 00:17:36,272 AUDIENCE: No. 352 00:17:36,272 --> 00:17:37,076 Because it's compounded. 353 00:17:37,076 --> 00:17:39,900 PROFESSOR: No, because it compounds. 354 00:17:39,900 --> 00:17:45,180 So if it's on the order of the millions of percentage, it's a 355 00:17:45,180 --> 00:17:47,780 very, very, very, very, high interest rate, because it 356 00:17:47,780 --> 00:17:49,270 compounds it really fast. 357 00:17:49,270 --> 00:17:53,400 It's 1.05 to the power of 365. 358 00:17:53,400 --> 00:17:55,500 It's a huge interest rate. 359 00:17:55,500 --> 00:18:01,020 That's on the high range but not uncommon. 360 00:18:01,020 --> 00:18:03,340 There is one study that I'm going to keep 361 00:18:03,340 --> 00:18:04,820 returning to, today. 362 00:18:04,820 --> 00:18:10,590 It's a lovely study on Pakistan, where some guy, 363 00:18:10,590 --> 00:18:13,725 called Aleem, went and talked to various moneylenders and 364 00:18:13,725 --> 00:18:16,390 collected very detailed data on their operation. 365 00:18:16,390 --> 00:18:20,130 And for Pakistan, he found that the interest they charge 366 00:18:20,130 --> 00:18:23,750 was 79%, almost. 367 00:18:23,750 --> 00:18:26,020 And you could say, well, this is because their 368 00:18:26,020 --> 00:18:28,030 own money is expensive. 369 00:18:28,030 --> 00:18:31,810 But they're own cost of capital is 33%. 370 00:18:31,810 --> 00:18:33,730 So their own money is expensive, because they are 371 00:18:33,730 --> 00:18:35,920 probably borrowing from the bank or borrowing from 372 00:18:35,920 --> 00:18:37,730 somewhere at some high cost. 373 00:18:37,730 --> 00:18:41,260 But there's still a big wedge between the cost of capital, 374 00:18:41,260 --> 00:18:44,000 for them, and what they charge the lender. 375 00:18:44,000 --> 00:18:44,870 So that's fact two. 376 00:18:44,870 --> 00:18:48,600 Keep in mind, high interest rate. 377 00:18:48,600 --> 00:18:51,020 Fact three is these interest rates are not only high, 378 00:18:51,020 --> 00:18:56,990 they're very variable, even within the same village. 379 00:18:56,990 --> 00:19:05,160 So if you go back to the Aleem study, the mean was 79%. 380 00:19:05,160 --> 00:19:09,090 The standard deviation is 38%. 381 00:19:09,090 --> 00:19:14,740 Which means that the 95% confidence interval includes a 382 00:19:14,740 --> 00:19:18,590 very low number, like 2% a year, and a very high 383 00:19:18,590 --> 00:19:20,460 number, like 150%. 384 00:19:20,460 --> 00:19:24,060 So it means you see, pretty frequently, in the same 385 00:19:24,060 --> 00:19:28,990 village, people borrowing at very, very different traits. 386 00:19:28,990 --> 00:19:31,720 So that is a certain other fact we have to have in mind. 387 00:19:31,720 --> 00:19:32,205 Yeah? 388 00:19:32,205 --> 00:19:35,115 AUDIENCE: Was that huge range, is that a reflection, then, 389 00:19:35,115 --> 00:19:38,510 that lenders are really adept at calculating, precisely, 390 00:19:38,510 --> 00:19:42,390 someone's actual likelihood of repayment or is that 391 00:19:42,390 --> 00:19:42,875 favoritism? 392 00:19:42,875 --> 00:19:43,845 PROFESSOR: Exactly. 393 00:19:43,845 --> 00:19:45,800 So we'd have to understand like how come 394 00:19:45,800 --> 00:19:47,050 this can be so variable? 395 00:19:50,850 --> 00:19:52,930 Is it likely that the likelihood of repayment can 396 00:19:52,930 --> 00:19:54,970 explain such a big range or do we have to 397 00:19:54,970 --> 00:19:56,680 think about other things? 398 00:19:56,680 --> 00:19:58,970 And if it's where the likelihood of repayment, can 399 00:19:58,970 --> 00:20:01,220 it explain that much difference? 400 00:20:01,220 --> 00:20:04,590 AUDIENCE: Is this taking into account the fact that if the 401 00:20:04,590 --> 00:20:07,484 lender had a spell, then he gets paid more, because he 402 00:20:07,484 --> 00:20:10,820 needs more money? 403 00:20:10,820 --> 00:20:11,670 PROFESSOR: No. 404 00:20:11,670 --> 00:20:13,980 That's the average rate that they charge. 405 00:20:16,870 --> 00:20:18,850 These are really moneylenders, like professional 406 00:20:18,850 --> 00:20:19,120 moneylenders. 407 00:20:19,120 --> 00:20:25,280 So I think what you're referring to is, sometimes, 408 00:20:25,280 --> 00:20:28,460 when people lend to each other, say, you know, you and 409 00:20:28,460 --> 00:20:29,710 I lend to each other. 410 00:20:29,710 --> 00:20:31,770 Because you have had a bad time, I lend you some money. 411 00:20:31,770 --> 00:20:33,860 And then when I get better, you lend me some money when 412 00:20:33,860 --> 00:20:35,550 you get better. 413 00:20:35,550 --> 00:20:39,160 When you see people doing that informally, what you're seeing 414 00:20:39,160 --> 00:20:42,590 is that people tend to pay higher interest rate when 415 00:20:42,590 --> 00:20:45,830 they're doing well and lower when they're doing poorly. 416 00:20:45,830 --> 00:20:51,950 But also, they tend to pay higher interest rates when the 417 00:20:51,950 --> 00:20:56,220 people who have lent them money are doing poorly. 418 00:20:56,220 --> 00:21:00,760 And they pay higher interest rate when the lender is doing 419 00:21:00,760 --> 00:21:04,080 poorly and lower interest rate when the lender is doing well. 420 00:21:04,080 --> 00:21:06,930 So the former could be just, because I don't have money, I 421 00:21:06,930 --> 00:21:08,000 can't reimburse. 422 00:21:08,000 --> 00:21:12,250 The latter is a sign that people sometimes use this 423 00:21:12,250 --> 00:21:15,370 informal lending between each other as a way of smoothing 424 00:21:15,370 --> 00:21:16,620 consumption. 425 00:21:19,030 --> 00:21:19,940 So we can remove that. 426 00:21:19,940 --> 00:21:23,710 These are more like a way of insuring, mutually insuring, 427 00:21:23,710 --> 00:21:25,420 like you saw in the last few lectures. 428 00:21:25,420 --> 00:21:27,810 Where these are like professional moneylenders that 429 00:21:27,810 --> 00:21:29,690 are charging different rates. 430 00:21:29,690 --> 00:21:33,140 So maybe we need to go back to your question. 431 00:21:33,140 --> 00:21:38,580 Is it the case that that can be explained by the ability to 432 00:21:38,580 --> 00:21:41,340 repay or do we need to bring in some more things, like 433 00:21:41,340 --> 00:21:45,240 favoritism, social relationships, what have you? 434 00:21:45,240 --> 00:21:46,300 So let's keep that in mind. 435 00:21:46,300 --> 00:21:52,230 We now have three, very little formal lending, high interest 436 00:21:52,230 --> 00:21:55,316 rates, very variable interest rates. 437 00:21:55,316 --> 00:22:01,110 The fourth fact, one of the dimension of variation is how 438 00:22:01,110 --> 00:22:02,990 rich you are. 439 00:22:02,990 --> 00:22:07,850 So the rich have larger loans, and they pay lower rates. 440 00:22:07,850 --> 00:22:17,015 So here's one fact for all of India showing that the range 441 00:22:17,015 --> 00:22:22,645 for the landless is between 28% and 125% interest rate, so 442 00:22:22,645 --> 00:22:25,630 again, this wide range with a pretty high interest rate. 443 00:22:25,630 --> 00:22:28,840 And the range for the people who have land is 444 00:22:28,840 --> 00:22:31,530 between 21% and 40%. 445 00:22:31,530 --> 00:22:34,510 So its both a smaller range, and it doesn't include the 446 00:22:34,510 --> 00:22:36,320 very high value. 447 00:22:36,320 --> 00:22:38,990 So the rich tend to pay-- and is this is just one fact. 448 00:22:38,990 --> 00:22:42,800 But we can accumulate these facts. 449 00:22:42,800 --> 00:22:45,310 That's kind of a representative fact of that. 450 00:22:45,310 --> 00:22:45,720 Yeah? 451 00:22:45,720 --> 00:22:48,210 AUDIENCE: To some degree, that variation is to be expected 452 00:22:48,210 --> 00:22:50,202 [INAUDIBLE] 453 00:22:50,202 --> 00:22:50,700 loan. 454 00:22:50,700 --> 00:22:54,186 So therefore, if it is a smaller loan, then, of course, 455 00:22:54,186 --> 00:22:56,710 the percent interest rate is going to be higher. 456 00:22:56,710 --> 00:22:57,210 PROFESSOR: Right. 457 00:22:57,210 --> 00:23:01,215 So to what extent can this be explained by fixed costs? 458 00:23:01,215 --> 00:23:02,900 That's the question we'll ask in a minute. 459 00:23:02,900 --> 00:23:04,190 I think you're exactly right. 460 00:23:04,190 --> 00:23:05,810 And that goes back to [INAUDIBLE] 461 00:23:05,810 --> 00:23:09,200 point earlier, that fixed costs will play a role. 462 00:23:09,200 --> 00:23:18,870 The issue we are going to ask is, why is it the case that, 463 00:23:18,870 --> 00:23:21,310 even if there is a relatively small fixed cost, that 464 00:23:21,310 --> 00:23:23,460 translates into such large differences in 465 00:23:23,460 --> 00:23:24,620 the interest rate? 466 00:23:24,620 --> 00:23:25,970 And we're going to see that. 467 00:23:25,970 --> 00:23:26,770 But you're exactly right. 468 00:23:26,770 --> 00:23:29,430 That's exactly the intuition is that it has to be that 469 00:23:29,430 --> 00:23:31,000 there is some fixed costs of lending 470 00:23:31,000 --> 00:23:32,250 buried here, somewhere. 471 00:23:37,950 --> 00:23:40,210 So in that case, there is this intuition of 472 00:23:40,210 --> 00:23:43,180 fixed cost we'll explain. 473 00:23:43,180 --> 00:23:45,300 We also, first, have to explain, why is it the case 474 00:23:45,300 --> 00:23:47,110 that the rich borrow more? 475 00:23:47,110 --> 00:23:48,570 After all, it's not because you're rich that you 476 00:23:48,570 --> 00:23:50,410 necessarily have better ideas? 477 00:23:50,410 --> 00:23:54,810 So to start with, should we take it as given that the rich 478 00:23:54,810 --> 00:23:56,520 should be able to borrow more? 479 00:23:56,520 --> 00:23:58,030 In a sense, that's something that's very intuitive, 480 00:23:58,030 --> 00:24:03,620 because, here, too, when you want borrow to pay for you 481 00:24:03,620 --> 00:24:08,020 house, they're going to ask you to pay at least 5% of the 482 00:24:08,020 --> 00:24:08,890 value of the house. 483 00:24:08,890 --> 00:24:11,370 So you can see, immediately, that the loan you can get is a 484 00:24:11,370 --> 00:24:13,100 function of how rich you are. 485 00:24:13,100 --> 00:24:14,550 Or your credit is also like that. 486 00:24:14,550 --> 00:24:16,360 They ask you what is your income, and they give you a 487 00:24:16,360 --> 00:24:19,550 credit line that sort of corresponds to your income. 488 00:24:19,550 --> 00:24:22,430 But if you think for a few minutes, in principle, where 489 00:24:22,430 --> 00:24:24,860 is that coming from. 490 00:24:24,860 --> 00:24:26,640 That's another thing we kind of have to understand. 491 00:24:26,640 --> 00:24:30,830 Does it come from the most basic model, that the loan you 492 00:24:30,830 --> 00:24:33,780 can get depends on how rich you are? 493 00:24:33,780 --> 00:24:35,370 It's not completely obvious. 494 00:24:35,370 --> 00:24:37,910 And then once we have that, we need to see, well, does that 495 00:24:37,910 --> 00:24:40,480 help us explain that the interest rate also varies with 496 00:24:40,480 --> 00:24:41,960 how rich you are? 497 00:24:41,960 --> 00:24:43,290 And that's where the fixed costs are 498 00:24:43,290 --> 00:24:47,495 going to be very helpful. 499 00:24:47,495 --> 00:24:48,745 The fifth fact. 500 00:24:51,230 --> 00:24:53,860 The fact that the rich pay lower interest 501 00:24:53,860 --> 00:24:56,020 rates, that's true. 502 00:24:56,020 --> 00:24:57,670 And that does seem to be linked to 503 00:24:57,670 --> 00:24:58,570 how much they borrow. 504 00:24:58,570 --> 00:25:01,860 The size of the loan is inversely related to the 505 00:25:01,860 --> 00:25:02,790 interest rate. 506 00:25:02,790 --> 00:25:05,320 So that's kind of the same fact as before, but it's true 507 00:25:05,320 --> 00:25:06,790 more generally. 508 00:25:06,790 --> 00:25:11,270 For example, in Udaipur, our famous district in Rajasthan, 509 00:25:11,270 --> 00:25:13,280 where we did all of these studies, we also asked people 510 00:25:13,280 --> 00:25:15,290 whether they borrow and how much they pay. 511 00:25:15,290 --> 00:25:21,380 And basically, the credit for interest from a loan varied 512 00:25:21,380 --> 00:25:24,460 for each hectare that you have. 513 00:25:24,460 --> 00:25:28,410 Actually, that's not a great fact to illustrate that. 514 00:25:28,410 --> 00:25:30,250 But the interest rate is also declining in 515 00:25:30,250 --> 00:25:32,770 how much you've borrowed. 516 00:25:32,770 --> 00:25:34,020 So those two are kind of related. 517 00:25:36,680 --> 00:25:39,050 And the sixth fact, which we are going to need to take into 518 00:25:39,050 --> 00:25:44,050 account, is that those high interest rates are going to be 519 00:25:44,050 --> 00:25:47,880 difficult to explain, mechanically, by default. 520 00:25:47,880 --> 00:25:52,050 Because, in fact, people do not seem to be defaulting. 521 00:25:52,050 --> 00:25:53,355 Default rates are very, very low. 522 00:25:56,680 --> 00:26:02,720 So to summarize, the poor can't 523 00:26:02,720 --> 00:26:06,060 borrow from formal lenders. 524 00:26:06,060 --> 00:26:07,620 The interest rates are high. 525 00:26:07,620 --> 00:26:10,140 The interest rates are variable. 526 00:26:10,140 --> 00:26:12,410 The rich borrow more. 527 00:26:12,410 --> 00:26:15,860 People who borrow more pay lower interest rates. 528 00:26:15,860 --> 00:26:17,930 And the default rates are very low. 529 00:26:17,930 --> 00:26:20,380 AUDIENCE: Why would a rich person borrow from an informal 530 00:26:20,380 --> 00:26:22,350 lender if they could just borrow from a bank? 531 00:26:22,350 --> 00:26:24,410 PROFESSOR: Rich meaning richer. 532 00:26:24,410 --> 00:26:28,550 It doesn't necessarily mean that they have 533 00:26:28,550 --> 00:26:31,320 access to the banks. 534 00:26:31,320 --> 00:26:33,140 So the name of the game-- 535 00:26:33,140 --> 00:26:33,880 yeah, Ben? 536 00:26:33,880 --> 00:26:36,820 AUDIENCE: Aren't the rates at the bank higher than the ones 537 00:26:36,820 --> 00:26:40,740 that the [INAUDIBLE]? 538 00:26:40,740 --> 00:26:42,810 PROFESSOR: So this is not in [INAUDIBLE]. 539 00:26:42,810 --> 00:26:44,020 This is in formal lending. 540 00:26:44,020 --> 00:26:45,940 AUDIENCE: Sorry, I mean informal lending. 541 00:26:45,940 --> 00:26:48,670 PROFESSOR: No, the rates at the banks 542 00:26:48,670 --> 00:26:50,090 are much, much lower. 543 00:26:50,090 --> 00:26:54,020 If you can get a bank loan, it's going to be at like, 544 00:26:54,020 --> 00:26:57,050 nominal, in Indian, 18% a year maximum. 545 00:27:00,800 --> 00:27:04,210 And then if you could get a microcredit loan, or you got a 546 00:27:04,210 --> 00:27:07,500 microcredit loan, the rate would be about, in India, 24% 547 00:27:07,500 --> 00:27:10,430 a year, maybe, in Bangladesh, around this. 548 00:27:10,430 --> 00:27:11,680 It's much higher in Mexico. 549 00:27:14,360 --> 00:27:18,630 The range charted by the microcredit agency tends to be 550 00:27:18,630 --> 00:27:23,224 outside this range, closer to the bank rates. 551 00:27:23,224 --> 00:27:25,924 AUDIENCE: For the fact the default rates are low, could 552 00:27:25,924 --> 00:27:28,625 that be that people don't borrow if they're desperate? 553 00:27:28,625 --> 00:27:30,589 Could that also be because they won't get a loan if 554 00:27:30,589 --> 00:27:31,571 they're desperate? 555 00:27:31,571 --> 00:27:34,026 Because they don't have enough capital, people won't trust 556 00:27:34,026 --> 00:27:37,850 them enough to loan to them in the first place. 557 00:27:37,850 --> 00:27:40,598 PROFESSOR: So the default rates are low. 558 00:27:40,598 --> 00:27:47,890 And people who borrow are often people who borrow for 559 00:27:47,890 --> 00:27:49,500 productive investments, et cetera. 560 00:27:49,500 --> 00:27:52,590 I think you're exactly right, that people will try not to 561 00:27:52,590 --> 00:27:56,510 lend to someone who has a very urgent need and might not be 562 00:27:56,510 --> 00:27:57,780 able to reimburse. 563 00:27:57,780 --> 00:28:00,820 So the fact of that the default rates are low is an 564 00:28:00,820 --> 00:28:01,950 equilibrium outcome. 565 00:28:01,950 --> 00:28:05,420 It's the result of how the lender decides to lend his 566 00:28:05,420 --> 00:28:06,960 money and how much monitoring they 567 00:28:06,960 --> 00:28:10,454 are exercising, obviously. 568 00:28:10,454 --> 00:28:14,918 AUDIENCE: So it would also make sense to give more loans 569 00:28:14,918 --> 00:28:17,894 to the rich, because it's not very profitable, the very 570 00:28:17,894 --> 00:28:20,208 small loans, if you're going to get a very small interest 571 00:28:20,208 --> 00:28:21,862 rate over it at the time. 572 00:28:21,862 --> 00:28:25,334 And like the money basically costs you, as a lender, to 573 00:28:25,334 --> 00:28:28,310 give up that remaining 10th of a loan to someone, especially 574 00:28:28,310 --> 00:28:29,740 [INAUDIBLE]. 575 00:28:29,740 --> 00:28:30,150 PROFESSOR: Right. 576 00:28:30,150 --> 00:28:33,720 So this is intuition coming back to the fixed cost. 577 00:28:33,720 --> 00:28:36,980 If the cost of money, for the moneylender, is proportional, 578 00:28:36,980 --> 00:28:40,300 he's also paying some interest rate to a depositor, people 579 00:28:40,300 --> 00:28:41,950 who are giving money to him. 580 00:28:41,950 --> 00:28:44,050 Or maybe he is getting money from a bigger moneylender. 581 00:28:44,050 --> 00:28:48,000 And so that proportional to how much he is getting. 582 00:28:48,000 --> 00:28:50,890 So the cost of fund, itself, is proportional. 583 00:28:50,890 --> 00:28:58,960 So the cost of fund would not explain why a small loan is 584 00:28:58,960 --> 00:29:00,410 more expensive than a big loan. 585 00:29:00,410 --> 00:29:04,170 So we have to add something to that, which is something about 586 00:29:04,170 --> 00:29:06,960 the cost of administering the loan. 587 00:29:06,960 --> 00:29:07,410 Exactly. 588 00:29:07,410 --> 00:29:09,650 AUDIENCE: [INAUDIBLE]. 589 00:29:09,650 --> 00:29:10,960 PROFESSOR: So that's exactly where we're heading. 590 00:29:10,960 --> 00:29:11,390 Yeah? 591 00:29:11,390 --> 00:29:15,665 AUDIENCE: What about default rates for the poor when 592 00:29:15,665 --> 00:29:17,565 they're borrowing from informal? 593 00:29:17,565 --> 00:29:19,230 PROFESSOR: This is that. 594 00:29:19,230 --> 00:29:19,780 This is what it is. 595 00:29:19,780 --> 00:29:22,372 The default rate for the poor, when they're borrowing from 596 00:29:22,372 --> 00:29:25,470 informal sources is very low. 597 00:29:25,470 --> 00:29:27,370 The default rate, from anyone, when they're borrowing from 598 00:29:27,370 --> 00:29:29,220 the bank, is very high. 599 00:29:29,220 --> 00:29:32,580 But that is because the bank is largely not a lending 600 00:29:32,580 --> 00:29:35,095 operation anymore. 601 00:29:35,095 --> 00:29:37,277 AUDIENCE: Is the reason the interest rates are different 602 00:29:37,277 --> 00:29:39,460 in different countries because the fixed cost environment 603 00:29:39,460 --> 00:29:39,945 [INAUDIBLE]. 604 00:29:39,945 --> 00:29:41,143 PROFESSOR: It might well be. 605 00:29:41,143 --> 00:29:44,250 And I want to go back to that. 606 00:29:44,250 --> 00:29:49,220 So let's write down some models that formalize a little 607 00:29:49,220 --> 00:29:52,090 bit the intuitions that have already come. 608 00:29:52,090 --> 00:29:54,670 So let's start with the simplest model. 609 00:29:54,670 --> 00:29:57,430 So the name of the game is going to take these facts and 610 00:29:57,430 --> 00:29:58,600 write down a model. 611 00:29:58,600 --> 00:30:01,460 The simplest model, with the fewest assumptions possible, 612 00:30:01,460 --> 00:30:06,200 is going to help us make sense of the facts. 613 00:30:06,200 --> 00:30:11,970 So let's start with your 14.01 type of model, 614 00:30:11,970 --> 00:30:13,810 like a basic model. 615 00:30:13,810 --> 00:30:17,320 What should the model be? 616 00:30:17,320 --> 00:30:23,320 Suppose that you have d% risk of default on any loan, but 617 00:30:23,320 --> 00:30:25,630 that's do the fact that someone's 618 00:30:25,630 --> 00:30:26,840 business has collapsed. 619 00:30:26,840 --> 00:30:30,560 It's not that they ran away with the money or whatever. 620 00:30:30,560 --> 00:30:31,680 It's just something happened. 621 00:30:31,680 --> 00:30:32,380 There business collapsed. 622 00:30:32,380 --> 00:30:33,140 They can't reimburse. 623 00:30:33,140 --> 00:30:34,000 So that's d%. 624 00:30:34,000 --> 00:30:36,710 That is observable by everyone. 625 00:30:36,710 --> 00:30:40,440 And let's assume that the growth interest rate is big R, 626 00:30:40,440 --> 00:30:44,000 so that's 1 plus little r. 627 00:30:44,000 --> 00:30:47,920 And suppose that banking or moneylending is 628 00:30:47,920 --> 00:30:49,325 a competitive industry. 629 00:30:52,880 --> 00:30:55,570 And so the moneylenders make no profit. 630 00:30:55,570 --> 00:30:58,045 We're going to return to that, whether it's a good assumption 631 00:30:58,045 --> 00:30:59,200 or a bad assumption. 632 00:30:59,200 --> 00:31:02,050 But suppose, for the moment, that lending is 633 00:31:02,050 --> 00:31:03,810 a competitive industry. 634 00:31:03,810 --> 00:31:07,430 So we are going to use a 0 profit condition. 635 00:31:07,430 --> 00:31:14,030 So the expected marginal product of capital has to be 1 636 00:31:14,030 --> 00:31:17,920 minus d times R, So the depositors, whatever you need 637 00:31:17,920 --> 00:31:21,430 to set to big R, such that you're depositor are getting 1 638 00:31:21,430 --> 00:31:23,040 minus d times R. 639 00:31:23,040 --> 00:31:24,880 So this d is very high. 640 00:31:24,880 --> 00:31:28,940 Then you need to set a higher interest rate, so that you can 641 00:31:28,940 --> 00:31:31,870 compensate your depositors. 642 00:31:31,870 --> 00:31:35,260 So that would be your basic model. 643 00:31:35,260 --> 00:31:40,940 Now, let's look at what kind of facts can it explain, what 644 00:31:40,940 --> 00:31:43,190 kind of fact can it not explain. 645 00:31:43,190 --> 00:31:46,100 So we go back to the fact. 646 00:31:46,100 --> 00:31:48,650 Does it have anything to tell us about formal versus 647 00:31:48,650 --> 00:31:49,900 informal lenders? 648 00:32:00,020 --> 00:32:02,120 In this model, everything is seen, observable. 649 00:32:02,120 --> 00:32:05,870 So, in principle, everybody should be able to lend to the 650 00:32:05,870 --> 00:32:07,726 poor, formal or informal. 651 00:32:07,726 --> 00:32:09,887 But this model doesn't tell us why the banks are not able to 652 00:32:09,887 --> 00:32:11,137 lend to the poor. 653 00:32:14,280 --> 00:32:16,140 Can it explain high interest rates? 654 00:32:16,140 --> 00:32:17,800 And under what conditions would it explain 655 00:32:17,800 --> 00:32:19,050 high interest rates? 656 00:32:22,918 --> 00:32:24,846 AUDIENCE: If under the assumption that the poor 657 00:32:24,846 --> 00:32:27,898 default more often than the rich, then it would make sense 658 00:32:27,898 --> 00:32:29,680 to charge them a higher interest rate 659 00:32:29,680 --> 00:32:30,190 PROFESSOR: Exactly. 660 00:32:30,190 --> 00:32:35,050 If the default rate was very high, you would explain the 661 00:32:35,050 --> 00:32:37,200 high interest rates. 662 00:32:37,200 --> 00:32:41,205 And if they were differently high for the poor than for the 663 00:32:41,205 --> 00:32:43,320 rich, you would also explain that the interest rate paid by 664 00:32:43,320 --> 00:32:45,460 the rich is higher than the poor. 665 00:32:45,460 --> 00:32:48,070 So the problem is that you can't both explain the high 666 00:32:48,070 --> 00:32:51,910 interest rates and the low default rate. 667 00:32:51,910 --> 00:32:53,960 Given the low default rate, you should have 668 00:32:53,960 --> 00:32:56,030 low interest rates. 669 00:32:56,030 --> 00:32:59,160 Likewise, given the low and reasonably similar default 670 00:32:59,160 --> 00:33:02,110 rate, there is no reason for the interest 671 00:33:02,110 --> 00:33:03,520 rate to be very variable. 672 00:33:07,300 --> 00:33:10,660 The interest rate paid by everyone should be the same. 673 00:33:10,660 --> 00:33:13,580 And there is no reason for the rich to be 674 00:33:13,580 --> 00:33:14,700 able to borrow more. 675 00:33:14,700 --> 00:33:16,560 You should be able to borrow what you need to borrow, as 676 00:33:16,560 --> 00:33:18,710 long as you're willing to reimburse. 677 00:33:18,710 --> 00:33:22,690 And you should also not be a lower interest rate. 678 00:33:22,690 --> 00:33:24,180 So that's kind or a long winded 679 00:33:24,180 --> 00:33:26,300 answer to your question. 680 00:33:26,300 --> 00:33:30,590 Even if the cost of fund is-- maybe the poor want less money 681 00:33:30,590 --> 00:33:33,060 because they have smaller projects. 682 00:33:33,060 --> 00:33:36,980 But in that case, if the only problem is the cost of fund 683 00:33:36,980 --> 00:33:40,400 multiplied by some chance of default, then that really 684 00:33:40,400 --> 00:33:42,640 shouldn't fit the facts. 685 00:33:42,640 --> 00:33:45,320 So we need to introduce something else to make sense 686 00:33:45,320 --> 00:33:45,980 of this fact. 687 00:33:45,980 --> 00:33:48,182 So I'm going to do it in two steps. 688 00:33:48,182 --> 00:33:52,460 First, I'm going to introduce the possibility that the 689 00:33:52,460 --> 00:33:56,010 borrower might want to run away with the money. 690 00:33:56,010 --> 00:34:00,040 So they have invested in their little enterprise. 691 00:34:00,040 --> 00:34:01,650 Their enterprise succeeded. 692 00:34:01,650 --> 00:34:06,250 But still they managed to escape with the money. 693 00:34:06,250 --> 00:34:11,460 So imagine that the bank or the moneylender lends to an 694 00:34:11,460 --> 00:34:16,850 entrepreneur who has a business, which will lead the 695 00:34:16,850 --> 00:34:23,170 F of k, when k units of capital are invested. 696 00:34:23,170 --> 00:34:25,489 So you invest k and you get F of k. 697 00:34:25,489 --> 00:34:28,340 So supposing you have a little shop, and you build some 698 00:34:28,340 --> 00:34:29,850 shelves, and you start your business, and 699 00:34:29,850 --> 00:34:32,389 you'll get F of k. 700 00:34:32,389 --> 00:34:36,110 So if you already have w, in order to invest k, you need to 701 00:34:36,110 --> 00:34:39,460 borrow k minus w, right? 702 00:34:39,460 --> 00:34:41,790 And then at the end of the period, you need to reimburse 703 00:34:41,790 --> 00:34:45,790 k minus w, multiplied by the growth interest rate, what 704 00:34:45,790 --> 00:34:47,130 you've borrowed plus the interest rate 705 00:34:47,130 --> 00:34:50,280 on what you've borrowed. 706 00:34:50,280 --> 00:34:53,679 Everyone's on board with that? 707 00:34:53,679 --> 00:34:57,830 So if we didn't have the chance that people run away 708 00:34:57,830 --> 00:35:00,350 with the money, we would be done. 709 00:35:00,350 --> 00:35:05,580 Now, suppose that you could spend some cost, h, and then 710 00:35:05,580 --> 00:35:07,300 you could run away with the money. 711 00:35:07,300 --> 00:35:10,690 And suppose that spending the cost, h, is not on the amount 712 00:35:10,690 --> 00:35:12,880 of money you've borrowed, but on the entire amount of money 713 00:35:12,880 --> 00:35:14,420 you've invested. 714 00:35:14,420 --> 00:35:16,890 So basically, in order to run away with the money, you need 715 00:35:16,890 --> 00:35:20,200 to dismantle the shop and then take it, move away somewhere. 716 00:35:20,200 --> 00:35:23,370 So you need to try to move the capital, so that's on the 717 00:35:23,370 --> 00:35:26,650 entire shop you need to pay the cost. 718 00:35:26,650 --> 00:35:29,340 And that's some cost, h. 719 00:35:29,340 --> 00:35:31,840 And then suppose that you need to pay some money to your 720 00:35:31,840 --> 00:35:32,540 depositors. 721 00:35:32,540 --> 00:35:35,510 So the cost of capital is D, low cost of capital. 722 00:35:35,510 --> 00:35:39,530 So if you're the moneylender, if he gets 1 in capital, he 723 00:35:39,530 --> 00:35:44,680 needs to repay D times 1 at the end of the day. 724 00:35:44,680 --> 00:35:48,400 So let's look at the borrower choice. 725 00:35:48,400 --> 00:35:52,150 And the end, when he's realized his money, he has a 726 00:35:52,150 --> 00:35:55,330 choice between repaying. 727 00:35:55,330 --> 00:35:59,560 So if he repays, he will get F of k, which is what he's made 728 00:35:59,560 --> 00:36:04,320 with his business, minus K minus w, what he has borrowed, 729 00:36:04,320 --> 00:36:08,540 multiplied by the interest rate, growth interest rate. 730 00:36:08,540 --> 00:36:11,430 So that's if he decides to behave. 731 00:36:11,430 --> 00:36:16,220 If he decides to run away, he still gets F of k minus the 732 00:36:16,220 --> 00:36:17,970 cost of running away. 733 00:36:17,970 --> 00:36:19,730 Now what is the lender going to do? 734 00:36:27,430 --> 00:36:29,670 At the end of the day, this is the choice that 735 00:36:29,670 --> 00:36:31,200 the borrower has. 736 00:36:31,200 --> 00:36:33,669 What's the lender going to do? 737 00:36:33,669 --> 00:36:34,128 Ben? 738 00:36:34,128 --> 00:36:36,882 AUDIENCE: Make R times k minus w term 739 00:36:36,882 --> 00:36:38,720 smaller than the hk term. 740 00:36:38,720 --> 00:36:39,040 PROFESSOR: Exactly. 741 00:36:39,040 --> 00:36:42,070 He's going to try to make it worthwhile for 742 00:36:42,070 --> 00:36:42,890 the borrower to reimburse. 743 00:36:42,890 --> 00:36:51,402 So it's going to set R times k minus w lower than hk, or at 744 00:36:51,402 --> 00:36:52,652 least equal. 745 00:36:56,830 --> 00:36:59,540 That is in order to make it worth the while for the 746 00:36:59,540 --> 00:37:02,300 borrower to reimburse. 747 00:37:02,300 --> 00:37:04,470 So suppose we equalize that. 748 00:37:04,470 --> 00:37:09,020 We make R times k minus w equal to h of k. 749 00:37:11,906 --> 00:37:14,940 That gives us the expression that's over here, which is k 750 00:37:14,940 --> 00:37:19,780 over w is R times R minus h. 751 00:37:25,280 --> 00:37:29,700 It looks like it's almost like a movie. 752 00:37:29,700 --> 00:37:34,110 Occasionally, some very, very noisy guys passing back. 753 00:37:34,110 --> 00:37:37,690 At any rate, so can you discuss, interpret, a little 754 00:37:37,690 --> 00:37:41,310 bit, this graph, this equation? 755 00:37:41,310 --> 00:37:42,680 What is it telling us? 756 00:37:42,680 --> 00:37:52,414 What is it telling us that is possibly interesting? 757 00:37:52,414 --> 00:37:54,382 A lot of it's already here. 758 00:37:57,826 --> 00:37:58,318 Yeah? 759 00:37:58,318 --> 00:38:00,778 AUDIENCE: You would assume that then interest rates would 760 00:38:00,778 --> 00:38:02,028 be lower, [INAUDIBLE]. 761 00:38:13,540 --> 00:38:15,570 PROFESSOR: They could play with R. But remember, they 762 00:38:15,570 --> 00:38:17,930 have the depositors on the other end. 763 00:38:17,930 --> 00:38:21,140 So they don't have much of a choice for R. So what are they 764 00:38:21,140 --> 00:38:23,610 going to try? 765 00:38:23,610 --> 00:38:25,780 What's the variable of adjustment for the lender? 766 00:38:28,462 --> 00:38:29,810 AUDIENCE: The loan size. 767 00:38:29,810 --> 00:38:31,580 PROFESSOR: It's the loan size. 768 00:38:31,580 --> 00:38:35,210 So what are they going to do if you're poorer? 769 00:38:38,210 --> 00:38:39,630 AUDIENCE: They'll make the loan size smaller. 770 00:38:39,630 --> 00:38:41,740 PROFESSOR: They'll make the loan size smaller. 771 00:38:41,740 --> 00:38:44,880 So R is not really a variable with which they can play much, 772 00:38:44,880 --> 00:38:47,250 because they have to pay the depositor on the other end. 773 00:38:47,250 --> 00:38:50,810 So they have to make 0 profit, otherwise they'll lose money. 774 00:38:50,810 --> 00:38:53,060 So what they are going to play with instead is they are going 775 00:38:53,060 --> 00:38:54,970 to play with the amount of money that is 776 00:38:54,970 --> 00:38:56,920 being lent to people. 777 00:38:56,920 --> 00:39:00,120 So what this is going to deliver for you is that you 778 00:39:00,120 --> 00:39:02,770 can't borrow as much as you want. 779 00:39:02,770 --> 00:39:06,100 You're going to be able to borrow some multiplier of how 780 00:39:06,100 --> 00:39:07,490 much money you already have. 781 00:39:07,490 --> 00:39:08,310 Yeah? 782 00:39:08,310 --> 00:39:11,372 AUDIENCE: Couldn't they also play with the cost of leaving, 783 00:39:11,372 --> 00:39:13,216 like increasing the cost. 784 00:39:13,216 --> 00:39:16,350 PROFESSOR: Right, they could also play with h, exactly. 785 00:39:16,350 --> 00:39:17,568 So what does that tell us? 786 00:39:17,568 --> 00:39:21,380 For example, how could they play with the cost of leaving? 787 00:39:21,380 --> 00:39:23,344 AUDIENCE: Regulations, bankruptcy law. 788 00:39:23,344 --> 00:39:25,450 PROFESSOR: They could play with bankruptcy law. 789 00:39:25,450 --> 00:39:26,950 And if they're an informal moneylender? 790 00:39:31,080 --> 00:39:34,160 So if they're informal, in a village, so they don't really 791 00:39:34,160 --> 00:39:36,220 have the option of using the police or whatever, 792 00:39:36,220 --> 00:39:37,470 what could they do? 793 00:39:40,513 --> 00:39:41,491 AUDIENCE: Well, if they're all part of the same village, 794 00:39:41,491 --> 00:39:44,126 everyone knows one another, just use the social ties. 795 00:39:44,126 --> 00:39:45,050 PROFESSOR: They could use social ties. 796 00:39:45,050 --> 00:39:47,038 What else could they do? 797 00:39:47,038 --> 00:39:48,529 AUDIENCE: They could beat the person. 798 00:39:48,529 --> 00:39:50,517 PROFESSOR: Sorry? 799 00:39:50,517 --> 00:39:52,505 AUDIENCE: If the person feels like there will be some 800 00:39:52,505 --> 00:39:53,996 physical punishment. 801 00:39:53,996 --> 00:39:57,475 PROFESSOR: Yeah, they could break people's kneecaps. 802 00:39:57,475 --> 00:40:02,920 Or at least they could credibly threaten to make 803 00:40:02,920 --> 00:40:04,995 people offers that they won't be able to refuse. 804 00:40:08,218 --> 00:40:09,212 Lisa? 805 00:40:09,212 --> 00:40:11,365 AUDIENCE: Which is probably why in some contexts, or at 806 00:40:11,365 --> 00:40:13,188 least some historical contexts, like the mafia and 807 00:40:13,188 --> 00:40:15,176 organized crime. 808 00:40:15,176 --> 00:40:15,673 PROFESSOR: Exactly. 809 00:40:15,673 --> 00:40:19,670 This is why the mafia is very well placed to lend to you, 810 00:40:19,670 --> 00:40:24,670 because they can very credibly commit to go and torture your 811 00:40:24,670 --> 00:40:27,939 sister and your first born if you don't send back the money. 812 00:40:27,939 --> 00:40:28,917 Yeah. 813 00:40:28,917 --> 00:40:29,406 AUDIENCE: I have a question. 814 00:40:29,406 --> 00:40:32,095 Before, we were talking about why the poor don't tend to 815 00:40:32,095 --> 00:40:35,029 default on their loans, which made the first probably not 816 00:40:35,029 --> 00:40:35,763 really [INAUDIBLE]. 817 00:40:35,763 --> 00:40:38,208 But why were there high default rates for the 818 00:40:38,208 --> 00:40:39,458 government loans? 819 00:40:41,870 --> 00:40:44,375 PROFESSOR: We can try and interpret that in context of 820 00:40:44,375 --> 00:40:46,980 this model. 821 00:40:46,980 --> 00:40:51,440 Can the government threaten to go break your kneecaps if you 822 00:40:51,440 --> 00:40:52,720 don't repay? 823 00:40:52,720 --> 00:40:53,460 No. 824 00:40:53,460 --> 00:40:54,862 Well, not very effectively. 825 00:40:54,862 --> 00:40:55,354 AUDIENCE: [INAUDIBLE]. 826 00:40:55,354 --> 00:40:55,846 PROFESSOR: Sorry? 827 00:40:55,846 --> 00:40:57,322 AUDIENCE: I said in Libya they can. 828 00:40:57,322 --> 00:40:59,290 PROFESSOR: In Libya they can. 829 00:40:59,290 --> 00:41:01,790 I don't know what's the default rate on Libyan loans, 830 00:41:01,790 --> 00:41:03,400 actually, now that you mention it. 831 00:41:03,400 --> 00:41:05,140 AUDIENCE: I bet it's a lot higher now. 832 00:41:05,140 --> 00:41:07,316 PROFESSOR: Well, yeah. 833 00:41:07,316 --> 00:41:10,710 But they're credibility of whether they can threaten 834 00:41:10,710 --> 00:41:12,695 breaking the kneecaps of people has certainly gone 835 00:41:12,695 --> 00:41:18,150 down, since their own kneecaps are in trouble at the moment. 836 00:41:18,150 --> 00:41:19,280 But that would be one thing. 837 00:41:19,280 --> 00:41:21,560 And another thing, going back to Svetlana's point, is that 838 00:41:21,560 --> 00:41:24,050 the bank also knows people less well. 839 00:41:24,050 --> 00:41:27,470 So it's kind of much easier to run away with the money of the 840 00:41:27,470 --> 00:41:29,830 bank, when the bank officer sits a 841 00:41:29,830 --> 00:41:30,510 little bit farther away. 842 00:41:30,510 --> 00:41:31,324 Sorry? 843 00:41:31,324 --> 00:41:34,320 AUDIENCE: Why don't they just keep stuff as security? 844 00:41:34,320 --> 00:41:34,730 PROFESSOR: Right. 845 00:41:34,730 --> 00:41:38,330 So they can also. 846 00:41:38,330 --> 00:41:43,820 This is like a way of making things costly is you keep some 847 00:41:43,820 --> 00:41:47,470 amount of money yourself. 848 00:41:47,470 --> 00:41:49,780 You keep some amount of the money yourself. 849 00:41:49,780 --> 00:41:54,570 So it could, here, be that part of the cost, hk, is that 850 00:41:54,570 --> 00:41:57,170 part of the capital invested, in fact-- 851 00:41:57,170 --> 00:42:01,340 this wasn't in the model, but we could include it. 852 00:42:01,340 --> 00:42:04,940 If you are going to invest that much in your company, you 853 00:42:04,940 --> 00:42:08,760 need to give me a bit on the side, which I'm going to keep 854 00:42:08,760 --> 00:42:12,300 as a collector for the loan. 855 00:42:12,300 --> 00:42:13,680 So that's a pretty good model. 856 00:42:13,680 --> 00:42:17,110 It explains a number of things. 857 00:42:17,110 --> 00:42:22,060 It explains, in particular, that the rich can borrow more. 858 00:42:22,060 --> 00:42:24,840 We're taking the fact that the default is low. 859 00:42:24,840 --> 00:42:28,790 The default rate is low not because people are very nice, 860 00:42:28,790 --> 00:42:32,120 not because of the kind, fundamental nature of the 861 00:42:32,120 --> 00:42:34,910 poor, but because things that set such that they won't go, 862 00:42:34,910 --> 00:42:36,000 they won't default. 863 00:42:36,000 --> 00:42:39,000 It's an equilibrium outcome. 864 00:42:39,000 --> 00:42:40,723 So the rich borrow more. 865 00:42:43,870 --> 00:42:46,230 The poor and the rich-- that should be green-- that the 866 00:42:46,230 --> 00:42:49,300 formal lender at a disadvantage. 867 00:42:49,300 --> 00:42:53,230 What we don't really get from this model is the facts on the 868 00:42:53,230 --> 00:42:54,720 interest rates. 869 00:42:54,720 --> 00:42:57,970 Here, the interest rate is being pinned down by the 870 00:42:57,970 --> 00:42:59,175 default rate. 871 00:42:59,175 --> 00:43:01,090 And it has nothing to do with how much you 872 00:43:01,090 --> 00:43:03,790 borrow in that model. 873 00:43:03,790 --> 00:43:08,470 So it is neither different for the poor or for the rich nor 874 00:43:08,470 --> 00:43:16,220 is it higher when you borrow less nor should it be very 875 00:43:16,220 --> 00:43:21,530 variable nor should it be particularly high, actually. 876 00:43:21,530 --> 00:43:24,050 The only thing that this model delivers, which is already a 877 00:43:24,050 --> 00:43:26,880 first thing, is this rationing, that some people 878 00:43:26,880 --> 00:43:29,720 won't be able to go as much as they would want to. 879 00:43:29,720 --> 00:43:32,060 Another thing is that this also does not deliver another 880 00:43:32,060 --> 00:43:35,280 fact, that some people might be unable to borrow at all. 881 00:43:35,280 --> 00:43:38,200 Here, everybody can borrow just some fraction 882 00:43:38,200 --> 00:43:39,040 of what they have. 883 00:43:39,040 --> 00:43:40,320 So if you have very little, you can 884 00:43:40,320 --> 00:43:42,250 borrow very small amounts. 885 00:43:42,250 --> 00:43:44,610 And if you have a lot, you can borrow a larger loan. 886 00:43:44,610 --> 00:43:46,940 But everybody has some access. 887 00:43:46,940 --> 00:43:48,920 So that model is missing something. 888 00:43:48,920 --> 00:43:49,150 Yeah? 889 00:43:49,150 --> 00:43:52,450 AUDIENCE: In this model, if you're a poor person, isn't 890 00:43:52,450 --> 00:43:56,790 your w lower, so, therfore, your R would be different? 891 00:43:56,790 --> 00:43:57,890 PROFESSOR: No. 892 00:43:57,890 --> 00:44:02,600 The w is lower, therefore, the k will be lower, but the R 893 00:44:02,600 --> 00:44:04,090 will be the same. 894 00:44:04,090 --> 00:44:06,440 Because in this model, the R is entirely pinned down by 895 00:44:06,440 --> 00:44:08,860 what you have to pay the depositor. 896 00:44:08,860 --> 00:44:11,550 So in this model, it's not going to be any default. 897 00:44:11,550 --> 00:44:14,212 And the only thing that is going to vary across people is 898 00:44:14,212 --> 00:44:15,462 the loan size. 899 00:44:22,250 --> 00:44:26,300 So we need to introduce one more thing, which you already 900 00:44:26,300 --> 00:44:28,580 mentioned, which is the idea of a fixed fee. 901 00:44:31,410 --> 00:44:36,130 We need to introduce that there is a fixed fee to 902 00:44:36,130 --> 00:44:38,190 administer the loan. 903 00:44:38,190 --> 00:44:40,910 So you already have all mentioned it as something 904 00:44:40,910 --> 00:44:44,350 rather obvious, so maybe I need to not spend much time to 905 00:44:44,350 --> 00:44:46,690 explain why there would be a fixed fee. 906 00:44:46,690 --> 00:44:51,120 So even a small loan requires some effort. 907 00:44:51,120 --> 00:44:53,970 So you need to open a line on your Excel 908 00:44:53,970 --> 00:44:55,940 document for this person. 909 00:44:55,940 --> 00:44:58,700 But more importantly, you need to go 910 00:44:58,700 --> 00:45:00,560 and do some due diligence. 911 00:45:00,560 --> 00:45:05,050 So Aleem describes how the moneylenders spend like a 912 00:45:05,050 --> 00:45:07,730 number of days to-- 913 00:45:07,730 --> 00:45:11,220 I wanted to check the X, which is it's an X. 914 00:45:11,220 --> 00:45:14,300 But you need to spend like two or three days, kind of go and 915 00:45:14,300 --> 00:45:18,290 visit the person, figure out who they are, who their 916 00:45:18,290 --> 00:45:21,760 siblings are, so that you can go break their kneecaps, and 917 00:45:21,760 --> 00:45:25,100 what their business is, and whether they are really 918 00:45:25,100 --> 00:45:28,100 intending to do the business, and then some kind of regular 919 00:45:28,100 --> 00:45:29,620 checking of what's going on. 920 00:45:29,620 --> 00:45:33,740 That's money, time, and time is money. 921 00:45:33,740 --> 00:45:37,710 So anything you want to do, it's going to cost you a 922 00:45:37,710 --> 00:45:39,950 little bit of money. 923 00:45:39,950 --> 00:45:42,500 So it seems kind of. 924 00:45:42,500 --> 00:45:44,490 [INAUDIBLE], you already made this point. 925 00:45:44,490 --> 00:45:47,420 So it's not very controversial. 926 00:45:47,420 --> 00:45:52,420 But that's going to play a big role. 927 00:45:52,420 --> 00:45:54,250 We already went through the intuition. 928 00:45:54,250 --> 00:45:57,690 Intuitively, now you have a fixed cost that you also need 929 00:45:57,690 --> 00:46:00,290 to recover on the loan. 930 00:46:00,290 --> 00:46:03,170 So the interest rate is going to need to adjust to recover 931 00:46:03,170 --> 00:46:04,850 that fixed cost. 932 00:46:04,850 --> 00:46:06,200 So that's the intuition. 933 00:46:06,200 --> 00:46:09,520 What I want to show you now is that the interest is going to 934 00:46:09,520 --> 00:46:11,390 more than adjust one for one. 935 00:46:11,390 --> 00:46:13,630 It's going to adjust many for one. 936 00:46:13,630 --> 00:46:16,420 So a small fixed cost is going to lead to a big explosion in 937 00:46:16,420 --> 00:46:17,770 interest rates. 938 00:46:17,770 --> 00:46:21,370 And let's see how that works. 939 00:46:21,370 --> 00:46:24,300 So we're going to assume that it's the same thing. 940 00:46:24,300 --> 00:46:28,415 You can run away with the money, by paying some cost. 941 00:46:31,200 --> 00:46:32,860 So you can run away. 942 00:46:32,860 --> 00:46:39,060 So it says, before, you can decide by running away. 943 00:46:39,060 --> 00:46:40,340 You can decide to run away. 944 00:46:40,340 --> 00:46:42,020 That's the second equation here. 945 00:46:42,020 --> 00:46:45,160 You could decide to run away at the end. 946 00:46:45,160 --> 00:46:48,460 So we are going to need to set how much you can borrow to 947 00:46:48,460 --> 00:46:51,780 make sure that you don't want to run away. 948 00:46:51,780 --> 00:46:55,520 But in addition, you have to pay some fixed costs, 949 00:46:55,520 --> 00:46:58,470 otherwise, if I give you the money without paying the fixed 950 00:46:58,470 --> 00:47:01,490 cost, you can run away at cost 0. 951 00:47:01,490 --> 00:47:05,170 So you have to pay some fixed cost on the loan, anyway. 952 00:47:05,170 --> 00:47:09,690 So now, the lender must satisfy two constraints when 953 00:47:09,690 --> 00:47:15,610 he picks both the interest rate and the amount he lends. 954 00:47:15,610 --> 00:47:18,860 Number one, he needs to still satisfy the previous 955 00:47:18,860 --> 00:47:23,840 constraint, which is the amount lent must not be too 956 00:47:23,840 --> 00:47:27,290 high to give people the temptation to run 957 00:47:27,290 --> 00:47:29,210 away with the money. 958 00:47:29,210 --> 00:47:33,070 Number two, the amount of interest that he's collecting, 959 00:47:33,070 --> 00:47:40,050 when he collects, must be sufficient to cover what he 960 00:47:40,050 --> 00:47:44,180 needs to pay the depositor, which is D, that's the growth 961 00:47:44,180 --> 00:47:46,275 interest rate paid to the depositor, 962 00:47:46,275 --> 00:47:48,750 plus the fixed cost. 963 00:47:48,750 --> 00:47:52,900 That is the new term, relative to what we had before. 964 00:47:52,900 --> 00:47:54,760 You OK with these two equations? 965 00:47:54,760 --> 00:47:56,030 So we need to manage these two things. 966 00:47:56,030 --> 00:47:58,560 Now we're going to combine these two equations. 967 00:47:58,560 --> 00:48:03,330 And when we combine these two equations, we get that hk must 968 00:48:03,330 --> 00:48:08,920 be equal to D times k minus w plus c. 969 00:48:08,920 --> 00:48:13,860 That's going to help us pin down what's the parameter here 970 00:48:13,860 --> 00:48:16,170 and what's free. 971 00:48:16,170 --> 00:48:17,420 What's the free variable? 972 00:48:22,830 --> 00:48:26,090 D is a choice or is it given to the moneylender? 973 00:48:26,090 --> 00:48:26,920 AUDIENCE: Given. 974 00:48:26,920 --> 00:48:27,860 PROFESSOR: It's given. 975 00:48:27,860 --> 00:48:29,576 How about w? 976 00:48:29,576 --> 00:48:30,074 AUDIENCE: It's given. 977 00:48:30,074 --> 00:48:31,070 PROFESSOR: That's given. 978 00:48:31,070 --> 00:48:34,458 How about c? 979 00:48:34,458 --> 00:48:35,412 AUDIENCE: [INAUDIBLE]. 980 00:48:35,412 --> 00:48:37,390 PROFESSOR: It's the fixed cost, so it can't really be 981 00:48:37,390 --> 00:48:40,470 fixed up. h is the other cost. 982 00:48:40,470 --> 00:48:42,050 That's the cost of running away. 983 00:48:42,050 --> 00:48:43,230 That's also given. 984 00:48:43,230 --> 00:48:45,436 So the only free variable here is k. 985 00:48:45,436 --> 00:48:47,991 AUDIENCE: Does c not change depending on how much money 986 00:48:47,991 --> 00:48:49,780 the person [INAUDIBLE]? 987 00:48:49,780 --> 00:48:50,540 PROFESSOR: No, that's the point. 988 00:48:50,540 --> 00:48:52,160 It's a fixed cost. 989 00:48:52,160 --> 00:48:56,370 So h is the part that is very relevant. 990 00:48:56,370 --> 00:48:58,590 It's the fixed cost that you need to pay, regardless, on 991 00:48:58,590 --> 00:49:00,140 the size of the loan. 992 00:49:00,140 --> 00:49:05,140 So in the lending cost, there is some cost that is fixed. 993 00:49:05,140 --> 00:49:05,980 That's c. 994 00:49:05,980 --> 00:49:08,920 It's like going and doing your two days of due diligence to 995 00:49:08,920 --> 00:49:16,040 know who the guy is and what is business and stuff. 996 00:49:16,040 --> 00:49:17,670 And h is the variable part. 997 00:49:21,500 --> 00:49:25,420 So the only thing that we have that is free in this 998 00:49:25,420 --> 00:49:26,830 equation now is k. 999 00:49:26,830 --> 00:49:30,140 So we can use it to determine what k is going to be. 1000 00:49:30,140 --> 00:49:37,560 And k is going to be D times w minus c divided by D minus h. 1001 00:49:37,560 --> 00:49:41,240 So what happens if dw is smaller than c? 1002 00:49:46,330 --> 00:49:46,813 Yeah? 1003 00:49:46,813 --> 00:49:49,228 AUDIENCE: Then you can't borrow if it's a negative. 1004 00:49:49,228 --> 00:49:51,170 PROFESSOR: Yeah, then it would be negative. 1005 00:49:51,170 --> 00:49:53,840 But if it's 0, you can't borrow anything. 1006 00:49:53,840 --> 00:49:56,840 So now we have a result that is slightly different than the 1007 00:49:56,840 --> 00:49:57,630 one we had before. 1008 00:49:57,630 --> 00:50:00,040 We now have a result where some people will not be able 1009 00:50:00,040 --> 00:50:02,210 to borrow at all. 1010 00:50:02,210 --> 00:50:06,890 Some people will not be able to borrow at all if the 1011 00:50:06,890 --> 00:50:10,330 amounts that they could borrow is too small to cover the 1012 00:50:10,330 --> 00:50:12,080 interest rate. 1013 00:50:12,080 --> 00:50:14,405 And how does k vary with w? 1014 00:50:20,400 --> 00:50:21,600 It's increasing. 1015 00:50:21,600 --> 00:50:24,730 When you're richer, you get to borrow more. 1016 00:50:24,730 --> 00:50:30,190 And with h, it's also increasing. 1017 00:50:30,190 --> 00:50:33,830 When you have a negative, which is under-- 1018 00:50:33,830 --> 00:50:37,440 if the cost of running away is bigger, than you also get to 1019 00:50:37,440 --> 00:50:38,570 borrow more. 1020 00:50:38,570 --> 00:50:41,660 That's the kneecap argument. 1021 00:50:41,660 --> 00:50:46,480 k is divided by something with a minus is front, so that 1022 00:50:46,480 --> 00:50:48,230 makes it negative. 1023 00:50:48,230 --> 00:50:49,870 So that's for the capital. 1024 00:50:49,870 --> 00:50:52,020 And now we can go back and look at the interest rate. 1025 00:50:55,750 --> 00:51:01,240 And so we can replace the value for k in the interest 1026 00:51:01,240 --> 00:51:01,735 rate expression. 1027 00:51:01,735 --> 00:51:06,380 And you get this expression, which is the interest rate 1028 00:51:06,380 --> 00:51:09,970 that someone pays is going to be-- you can see that people 1029 00:51:09,970 --> 00:51:16,660 will pay a higher interest rate if they borrow less. 1030 00:51:16,660 --> 00:51:19,000 People will pay a higher interest rate when the borrow 1031 00:51:19,000 --> 00:51:23,850 less, simply because the fixed costs has to be spread over a 1032 00:51:23,850 --> 00:51:25,900 smaller amount of money. 1033 00:51:25,900 --> 00:51:30,380 And then if replace what they can borrow in this expression, 1034 00:51:30,380 --> 00:51:32,710 we're getting the expression for the interest rate as a 1035 00:51:32,710 --> 00:51:37,330 function of all of the exogenous stuff in the model. 1036 00:51:37,330 --> 00:51:43,750 So what they are paying is the cost, D, plus c times D minus 1037 00:51:43,750 --> 00:51:48,420 h divided by hw minus c. 1038 00:51:48,420 --> 00:51:53,440 So what you're getting is a multiplier property, which is 1039 00:51:53,440 --> 00:51:57,760 when you increase the cost to a depositor by 1, you increase 1040 00:51:57,760 --> 00:52:01,310 the interest rate by more than 1. 1041 00:52:01,310 --> 00:52:03,410 Every time you increase the interest rate paid to the 1042 00:52:03,410 --> 00:52:05,660 depositor by 1%, you increase the interest rate 1043 00:52:05,660 --> 00:52:07,240 by more than 1. 1044 00:52:07,240 --> 00:52:14,340 And likewise, when you increase the the fixed cost c 1045 00:52:14,340 --> 00:52:19,020 by 1, you increase the interest rate paid 1046 00:52:19,020 --> 00:52:20,270 by more than 1. 1047 00:52:24,730 --> 00:52:27,790 And then the last thing you have is the interest rate, 1048 00:52:27,790 --> 00:52:32,050 also, depends on your wealth and also in 1049 00:52:32,050 --> 00:52:33,790 this multiplier way. 1050 00:52:33,790 --> 00:52:38,230 So now small differences in the cost of funds, small 1051 00:52:38,230 --> 00:52:41,880 differences in the cost of monitoring the loans, either 1052 00:52:41,880 --> 00:52:44,920 the fixed costs or the variable costs, or small 1053 00:52:44,920 --> 00:52:49,570 differences in wealth are all things that are going to lead 1054 00:52:49,570 --> 00:52:53,190 to big differences in interest rates. 1055 00:52:53,190 --> 00:52:54,580 This is what we see in the math. 1056 00:52:54,580 --> 00:52:57,220 But can you think of an intuition behind this 1057 00:52:57,220 --> 00:52:58,170 multiplier property? 1058 00:52:58,170 --> 00:53:00,510 Why do we have this multiplier property? 1059 00:53:00,510 --> 00:53:02,710 Why is it that it's just not one for one? 1060 00:53:14,600 --> 00:53:15,971 Think of Libya. 1061 00:53:15,971 --> 00:53:18,985 AUDIENCE: People pay the cost on a risk [INAUDIBLE]. 1062 00:53:18,985 --> 00:53:20,650 PROFESSOR: Sorry? 1063 00:53:20,650 --> 00:53:23,870 AUDIENCE: Risk has a cost. 1064 00:53:23,870 --> 00:53:24,790 PROFESSOR: That could be true. 1065 00:53:24,790 --> 00:53:27,250 But think in the context of this model. 1066 00:53:27,250 --> 00:53:30,690 Without even exiting the model, what is happening in 1067 00:53:30,690 --> 00:53:34,210 this model which tends to set up anything that will push the 1068 00:53:34,210 --> 00:53:38,630 interest rate up a bit, like the cost of fund or the amount 1069 00:53:38,630 --> 00:53:42,770 of you have or the cost of monitoring or the cost of 1070 00:53:42,770 --> 00:53:44,900 running away? 1071 00:53:44,900 --> 00:53:47,090 Anything that will push the interest rate a bit 1072 00:53:47,090 --> 00:53:48,595 with feed on itself. 1073 00:53:52,060 --> 00:53:55,490 It appears in the math, here, very clearly, but try to think 1074 00:53:55,490 --> 00:53:56,980 of the intuition behind this. 1075 00:54:01,880 --> 00:54:04,330 AUDIENCE: As interest rates increase, there's going to be 1076 00:54:04,330 --> 00:54:06,290 more and more people susceptible to 1077 00:54:06,290 --> 00:54:07,270 not paying it back. 1078 00:54:07,270 --> 00:54:09,066 So therefore, it just perpetuates the negative 1079 00:54:09,066 --> 00:54:10,210 feedback cycle. 1080 00:54:10,210 --> 00:54:10,870 PROFESSOR: Exactly. 1081 00:54:10,870 --> 00:54:16,540 So it's not so much more people, but each person wants 1082 00:54:16,540 --> 00:54:18,650 to run away more. 1083 00:54:18,650 --> 00:54:21,480 So when the interest rate increases, it makes you run 1084 00:54:21,480 --> 00:54:24,850 away more, which is necessary to increase the interest rate 1085 00:54:24,850 --> 00:54:27,577 further, which makes you run away more, et cetera, et 1086 00:54:27,577 --> 00:54:29,470 cetera, up to the point where it stabilizes. 1087 00:54:29,470 --> 00:54:32,500 And then for some people, it might never stabilize. 1088 00:54:32,500 --> 00:54:35,340 And these people will not be able to borrow at all. 1089 00:54:35,340 --> 00:54:41,990 So here you won't be able to borrow if hw is too small. 1090 00:54:41,990 --> 00:54:46,910 If hw is smaller than c, you won't borrow. 1091 00:54:46,910 --> 00:54:49,740 The interest rate would be infinite. 1092 00:54:49,740 --> 00:54:53,460 Because that spiral will not stabilize. 1093 00:54:53,460 --> 00:54:55,444 For other people, it just feeds on itself. 1094 00:54:58,610 --> 00:55:06,370 So now this model can explain, pretty much, all of our facts. 1095 00:55:09,790 --> 00:55:12,840 The poor can't borrow from the formal lenders, while some 1096 00:55:12,840 --> 00:55:15,763 people won't be able to borrow at all. 1097 00:55:15,763 --> 00:55:19,190 And in particular, people will be not very able to borrow 1098 00:55:19,190 --> 00:55:24,455 from places which are not able to impose high costs. 1099 00:55:24,455 --> 00:55:28,270 They are just going to not be able to borrow to the poor if 1100 00:55:28,270 --> 00:55:30,440 they want to get the money back. 1101 00:55:30,440 --> 00:55:32,230 The interest rates are high. 1102 00:55:32,230 --> 00:55:37,250 That's because if the cost of fund is D, the interest rate 1103 00:55:37,250 --> 00:55:38,870 multiplier relative to that, so you can 1104 00:55:38,870 --> 00:55:40,150 have a big wedge now. 1105 00:55:40,150 --> 00:55:41,710 It's not only the default rate. 1106 00:55:41,710 --> 00:55:46,200 It's like all this effort that you have to pay to get people 1107 00:55:46,200 --> 00:55:47,450 to reimburse. 1108 00:55:49,300 --> 00:55:51,840 The interest rates are very variable. 1109 00:55:51,840 --> 00:55:57,330 And, in part, because, for example, you know someone a 1110 00:55:57,330 --> 00:55:57,920 little better. 1111 00:55:57,920 --> 00:56:00,700 So that goes back to the question that was before about 1112 00:56:00,700 --> 00:56:01,480 favoritism. 1113 00:56:01,480 --> 00:56:02,330 Maybe it's favoritism. 1114 00:56:02,330 --> 00:56:03,560 You know them better. 1115 00:56:03,560 --> 00:56:07,150 Well, here, if you know someone better, you can indeed 1116 00:56:07,150 --> 00:56:10,240 lend them at lower rates, because knowing someone 1117 00:56:10,240 --> 00:56:14,380 better, maybe, reduces the fixed cost, c, or maybe it 1118 00:56:14,380 --> 00:56:16,420 increases the cost of running away. 1119 00:56:16,420 --> 00:56:20,220 All of this will have big effect, big jump on the 1120 00:56:20,220 --> 00:56:20,830 interest rate. 1121 00:56:20,830 --> 00:56:24,170 So you could have very large variation in the interest rate 1122 00:56:24,170 --> 00:56:26,570 as a function of this h and c, et cetera, 1123 00:56:26,570 --> 00:56:27,820 within the same village. 1124 00:56:32,490 --> 00:56:34,490 So that's the interests are variable. 1125 00:56:34,490 --> 00:56:35,970 The rich can borrow more. 1126 00:56:35,970 --> 00:56:38,900 That's because what you can borrow is a function of how 1127 00:56:38,900 --> 00:56:40,780 much wealth you have. 1128 00:56:40,780 --> 00:56:43,220 And the rich pay lower interest rates, because they 1129 00:56:43,220 --> 00:56:43,910 borrow more. 1130 00:56:43,910 --> 00:56:45,630 That's because of the fixed costs. 1131 00:56:45,630 --> 00:56:47,330 And that's good to a point. 1132 00:56:47,330 --> 00:56:49,700 And that's all in equilibrium. 1133 00:56:49,700 --> 00:56:51,820 In this model, there are no defaults, since everything is 1134 00:56:51,820 --> 00:56:54,160 set up to ensure there is no defaults. 1135 00:56:54,160 --> 00:56:56,340 So the default rates are nothing but automatic. 1136 00:56:56,340 --> 00:56:59,810 They are the result of people setting the 1137 00:56:59,810 --> 00:57:01,700 interest rate that way. 1138 00:57:01,700 --> 00:57:06,130 So I think, at an intuition level, you had seen where this 1139 00:57:06,130 --> 00:57:07,040 was coming. 1140 00:57:07,040 --> 00:57:10,490 But you can see that introducing these fixed costs, 1141 00:57:10,490 --> 00:57:15,000 plus this proportional cost of running away helps us kind of 1142 00:57:15,000 --> 00:57:16,900 cover, pretty much, all of our bases in terms 1143 00:57:16,900 --> 00:57:19,540 of the basic facts. 1144 00:57:19,540 --> 00:57:22,320 And then we can go a little bit further, and we can start 1145 00:57:22,320 --> 00:57:26,920 thinking about other things that we might try to explain 1146 00:57:26,920 --> 00:57:29,120 with this model. 1147 00:57:29,120 --> 00:57:32,940 So moneylenders are close to the people. 1148 00:57:32,940 --> 00:57:36,120 So they are the ones who area able to borrow. 1149 00:57:36,120 --> 00:57:37,840 They are the ones who are able to punish people. 1150 00:57:37,840 --> 00:57:41,160 They are the ones for which the fixed cost is lower. 1151 00:57:41,160 --> 00:57:44,300 They may be able to impose large 1152 00:57:44,300 --> 00:57:47,320 penalties, like the mafia. 1153 00:57:47,320 --> 00:57:51,530 An example we have in the book is, in India, people called 1154 00:57:51,530 --> 00:57:55,660 Kabuliwala are the moneylenders or were the 1155 00:57:55,660 --> 00:57:56,770 moneylenders of choice. 1156 00:57:56,770 --> 00:57:58,170 I don't know if they are still there. 1157 00:57:58,170 --> 00:58:01,370 Kabuliwala, the men from Kabul, who had this reputation 1158 00:58:01,370 --> 00:58:03,290 of being very fierce. 1159 00:58:03,290 --> 00:58:07,600 So every like Indian child read the story about the man 1160 00:58:07,600 --> 00:58:12,270 from Kabul, with his tender heart, but who ends up killing 1161 00:58:12,270 --> 00:58:17,160 someone, because that person has treated them badly. 1162 00:58:17,160 --> 00:58:20,445 And so you would see a villager telling this story. 1163 00:58:20,445 --> 00:58:24,670 Or you would see these guys coming under the pretense of 1164 00:58:24,670 --> 00:58:30,010 selling you dried fruits and, in fact, being moneylenders. 1165 00:58:30,010 --> 00:58:34,020 Because they are the ones who you knew that they would be 1166 00:58:34,020 --> 00:58:38,790 able to get at you, with a very persuasive argument, if 1167 00:58:38,790 --> 00:58:41,151 you were not going to be able to lend. 1168 00:58:41,151 --> 00:58:43,367 AUDIENCE: I've only read the article so far, so this might 1169 00:58:43,367 --> 00:58:46,480 be in the book, and I don't know this yet. 1170 00:58:46,480 --> 00:58:49,532 I was a little curious about why the banks never work 1171 00:58:49,532 --> 00:58:50,690 directly with these people? 1172 00:58:50,690 --> 00:58:52,180 Is it like a liability thing? 1173 00:58:52,180 --> 00:58:53,206 PROFESSOR: Right. 1174 00:58:53,206 --> 00:59:00,010 So there's an example of that where Citibank, in India, 1175 00:59:00,010 --> 00:59:02,600 decided that, why wouldn't they use these guys. 1176 00:59:02,600 --> 00:59:08,290 So they tried to use the kind of local thugs to repossess 1177 00:59:08,290 --> 00:59:10,280 their car loans. 1178 00:59:10,280 --> 00:59:12,800 But once it got found out, like they 1179 00:59:12,800 --> 00:59:14,340 ran into big trouble. 1180 00:59:14,340 --> 00:59:19,160 And they had to stop that operation. 1181 00:59:19,160 --> 00:59:22,950 And it's not clear whether or not it's welfare increasing to 1182 00:59:22,950 --> 00:59:25,310 forbid Citibank to use the goondas to 1183 00:59:25,310 --> 00:59:26,690 recover their car loans. 1184 00:59:26,690 --> 00:59:27,500 But they tried. 1185 00:59:27,500 --> 00:59:30,790 And then they ran into problems with the law. 1186 00:59:30,790 --> 00:59:33,200 So it turns out that it's not legal to kill people who don't 1187 00:59:33,200 --> 00:59:35,140 reimburse your loan. 1188 00:59:35,140 --> 00:59:38,260 So that was the problem, exactly. 1189 00:59:38,260 --> 00:59:40,610 That's a good point. 1190 00:59:40,610 --> 00:59:47,220 There is another anecdote in the book about formal banks-- 1191 00:59:47,220 --> 00:59:49,340 I don't remember if it was Citibank-- 1192 00:59:49,340 --> 00:59:53,560 threatening to send people eunuchs. 1193 00:59:53,560 --> 00:59:57,730 Because, in India, eunuchs showing their private parts is 1194 00:59:57,730 --> 01:00:03,630 supposed to be like a bad omen. 1195 01:00:03,630 --> 01:00:07,410 So the thing is, pay up, or we'll send the 1196 01:00:07,410 --> 01:00:09,495 eunuch to see you. 1197 01:00:09,495 --> 01:00:11,300 AUDIENCE: Did you say, eunuch? 1198 01:00:11,300 --> 01:00:12,290 PROFESSOR: I don't know how-- 1199 01:00:12,290 --> 01:00:12,840 eunuchs. 1200 01:00:12,840 --> 01:00:14,370 AUDIENCE: You know, eunuch. 1201 01:00:14,370 --> 01:00:17,264 PROFESSOR: Eunuch, eunuchs. 1202 01:00:17,264 --> 01:00:19,195 AUDIENCE: So it's just like their presence is considered 1203 01:00:19,195 --> 01:00:21,570 like threat in itself? 1204 01:00:21,570 --> 01:00:22,820 PROFESSOR: Their exposition. 1205 01:00:25,460 --> 01:00:27,835 If they expose their private parts, it's 1206 01:00:27,835 --> 01:00:30,652 supposed to be bad. 1207 01:00:30,652 --> 01:00:33,634 AUDIENCE: Seriously, the banks were hiring people to flash 1208 01:00:33,634 --> 01:00:35,622 themselves? 1209 01:00:35,622 --> 01:00:37,113 PROFESSOR: Not people, eunuchs. 1210 01:00:37,113 --> 01:00:40,592 I mean, people who are eunuchs! 1211 01:00:40,592 --> 01:00:43,077 Not just anybody. 1212 01:00:45,580 --> 01:00:47,205 Not anyone. 1213 01:00:47,205 --> 01:00:48,510 It's a very specialized industry. 1214 01:00:53,640 --> 01:00:55,480 So that explains why the 1215 01:00:55,480 --> 01:00:57,720 moneylenders have a good business. 1216 01:00:57,720 --> 01:01:01,030 Basically, it's a bit like, you have to resort to very 1217 01:01:01,030 --> 01:01:01,920 complicated stuff. 1218 01:01:01,920 --> 01:01:04,260 If you're a bank, you can't threaten to 1219 01:01:04,260 --> 01:01:05,960 kill people, et cetera. 1220 01:01:05,960 --> 01:01:09,180 So the moneylenders are well placed. 1221 01:01:09,180 --> 01:01:11,780 The problem, however, is that moneylenders don't have, 1222 01:01:11,780 --> 01:01:15,390 themselves, access to very cheap funds. 1223 01:01:15,390 --> 01:01:19,720 Because if you have savings, maybe giving them to a 1224 01:01:19,720 --> 01:01:23,880 moneylender is not the best thing you can do. 1225 01:01:23,880 --> 01:01:27,880 So moneylenders, themselves, they're cost of fund is high. 1226 01:01:27,880 --> 01:01:30,700 And there is also a multiplier on the cost of funds, which 1227 01:01:30,700 --> 01:01:32,226 explains why the interest rates are high. 1228 01:01:34,830 --> 01:01:38,580 So you'd explain why you have a moneylender doing a good job 1229 01:01:38,580 --> 01:01:40,750 and why their interest rates are so high. 1230 01:01:40,750 --> 01:01:43,690 So it is not entirely clear, when you're talking about 1231 01:01:43,690 --> 01:01:48,530 driving them away, that they are necessarily bad people 1232 01:01:48,530 --> 01:01:50,440 trying to exploit the poor. 1233 01:01:50,440 --> 01:01:53,480 They also have their own cost of funds that it is expensive. 1234 01:01:53,480 --> 01:01:56,330 And then they are trying to make a living in this way. 1235 01:01:56,330 --> 01:01:57,324 Yep. 1236 01:01:57,324 --> 01:01:59,312 AUDIENCE: Well, if formal institutions can't work 1237 01:01:59,312 --> 01:02:02,791 directly with the poor borrowers and enter that 1238 01:02:02,791 --> 01:02:06,270 interaction, why can't they work with the moneylenders, 1239 01:02:06,270 --> 01:02:07,761 since those would borrow larger sums? 1240 01:02:07,761 --> 01:02:13,725 And they could be like a private person who would just 1241 01:02:13,725 --> 01:02:15,961 decides to borrow from someone and later decides to do 1242 01:02:15,961 --> 01:02:16,707 something with it. 1243 01:02:16,707 --> 01:02:18,210 Why can't that [INAUDIBLE]? 1244 01:02:18,210 --> 01:02:20,837 PROFESSOR: I think, in a lot of cases, it's sort of 1245 01:02:20,837 --> 01:02:23,780 happening, which is the moneylender is like a big 1246 01:02:23,780 --> 01:02:29,140 landlord, who will take a loan from the bank. 1247 01:02:29,140 --> 01:02:31,540 So I think part of the money that the moneylender is 1248 01:02:31,540 --> 01:02:34,480 getting is precisely coming from the bank. 1249 01:02:34,480 --> 01:02:36,780 So that intermediation exists. 1250 01:02:36,780 --> 01:02:39,900 Maybe not be officially, because moneylending 1251 01:02:39,900 --> 01:02:42,990 is often not legal. 1252 01:02:42,990 --> 01:02:45,770 But they just go and they borrow some money. 1253 01:02:45,770 --> 01:02:47,258 And then they relend it. 1254 01:02:47,258 --> 01:02:48,512 And that's it. 1255 01:02:48,512 --> 01:02:51,227 AUDIENCE: How do these rates change with the objective of 1256 01:02:51,227 --> 01:02:54,591 the lending institutions and the objective of the people 1257 01:02:54,591 --> 01:02:55,769 who are receiving the loans? 1258 01:02:55,769 --> 01:02:59,546 So if there was a social purpose, as opposed to a 1259 01:02:59,546 --> 01:03:03,784 for-profit purpose, then the spread would be smaller. 1260 01:03:03,784 --> 01:03:07,053 You'd be trying to break even versus trying to make some 1261 01:03:07,053 --> 01:03:09,390 income off of the person you're lending to. 1262 01:03:09,390 --> 01:03:12,300 And I also imagine, if you're lending to someone who is just 1263 01:03:12,300 --> 01:03:15,050 trying to smooth their consumption, they'd be more 1264 01:03:15,050 --> 01:03:17,900 likely to pay you back then if you were lending to someone 1265 01:03:17,900 --> 01:03:20,530 who was trying to start a business then, who's success 1266 01:03:20,530 --> 01:03:22,380 rate might also be low. 1267 01:03:22,380 --> 01:03:25,255 PROFESSOR: So in this particular model, we have 1268 01:03:25,255 --> 01:03:26,550 assumed-- and, in fact, I'm going to come back 1269 01:03:26,550 --> 01:03:28,010 to that in a moment-- 1270 01:03:28,010 --> 01:03:29,670 that there is perfect competition between 1271 01:03:29,670 --> 01:03:31,880 moneylenders. 1272 01:03:31,880 --> 01:03:34,650 So people, are here, breaking even. 1273 01:03:34,650 --> 01:03:38,060 So in that sense, you can't do better from that without 1274 01:03:38,060 --> 01:03:39,110 starting to lose money. 1275 01:03:39,110 --> 01:03:42,800 However, you're exactly right that someone could decide that 1276 01:03:42,800 --> 01:03:45,940 it is worthwhile for them subsidize the interest rate. 1277 01:03:45,940 --> 01:03:49,020 For example, you are like an NGO. 1278 01:03:49,020 --> 01:03:51,430 And you want to do something good for the poor. 1279 01:03:51,430 --> 01:03:54,210 You could decide that you're going to want to subsidize the 1280 01:03:54,210 --> 01:03:56,140 interest rate, a bit. 1281 01:03:56,140 --> 01:04:00,955 And then you're going to benefit from the multiplier 1282 01:04:00,955 --> 01:04:03,440 rate the other way. 1283 01:04:03,440 --> 01:04:09,080 So if you were good at it, if someone had the local presence 1284 01:04:09,080 --> 01:04:11,570 and were able to replicate what the moneylenders are 1285 01:04:11,570 --> 01:04:16,000 doing, in terms of lowering the rate of running away with 1286 01:04:16,000 --> 01:04:18,870 the money and lowering the fixed cost of lending, and 1287 01:04:18,870 --> 01:04:21,400 they combined that with some subsidies of the interest 1288 01:04:21,400 --> 01:04:26,750 rate, then the multiplier would play in your favor. 1289 01:04:26,750 --> 01:04:31,370 And that's where the microcredit comes in. 1290 01:04:31,370 --> 01:04:36,530 When we talk about microcredit, in a way, they 1291 01:04:36,530 --> 01:04:39,510 are still, say, trying to break even. 1292 01:04:39,510 --> 01:04:42,850 Or they might even be willing to lose a little bit of money. 1293 01:04:42,850 --> 01:04:45,370 And this losing a little bit of money might translate into 1294 01:04:45,370 --> 01:04:47,700 a large drop in the interest rate. 1295 01:04:47,700 --> 01:04:48,410 You're exactly right. 1296 01:04:48,410 --> 01:04:51,820 If you're willing to, any profit that you're going to 1297 01:04:51,820 --> 01:04:56,970 give away might translate into a lot of money saved, from the 1298 01:04:56,970 --> 01:04:58,570 point of view of the lender. 1299 01:04:58,570 --> 01:05:02,560 You're also right on the other end, which is all of these 1300 01:05:02,560 --> 01:05:04,900 things depend on the propensity of people to run 1301 01:05:04,900 --> 01:05:05,880 away and things like that. 1302 01:05:05,880 --> 01:05:08,490 If you could identify good borrowers that are not going 1303 01:05:08,490 --> 01:05:13,030 to default, they are borrowers with a big h, in a sense. 1304 01:05:13,030 --> 01:05:14,960 And there are borrowers you could lend to 1305 01:05:14,960 --> 01:05:17,210 with a lower rate. 1306 01:05:17,210 --> 01:05:19,830 The problem is, for the moneylender or for the bank, 1307 01:05:19,830 --> 01:05:22,170 is whether they can identify people with a low 1308 01:05:22,170 --> 01:05:24,472 or high h or not. 1309 01:05:30,350 --> 01:05:33,560 In this world, you would have what you see with 1310 01:05:33,560 --> 01:05:36,070 moneylenders, which is moneylenders that charge very 1311 01:05:36,070 --> 01:05:38,820 high rates, get very low defaults, in equilibrium, they 1312 01:05:38,820 --> 01:05:42,140 don't need to break anybody's kneecap, as long as it's known 1313 01:05:42,140 --> 01:05:44,630 that that's what would happen. 1314 01:05:48,030 --> 01:05:51,550 Another story about the moneylenders, however, is that 1315 01:05:51,550 --> 01:05:58,720 it is not that they just have to charge this high rates and 1316 01:05:58,720 --> 01:06:02,330 variable rates because of the fixed cost of lending and 1317 01:06:02,330 --> 01:06:05,230 monitoring the loans, but because they 1318 01:06:05,230 --> 01:06:07,850 are monopoly lenders. 1319 01:06:07,850 --> 01:06:11,560 So that's another thing that you often hear is that these 1320 01:06:11,560 --> 01:06:16,560 guys, it's one game in town in the village. 1321 01:06:16,560 --> 01:06:20,430 They are the only one who can lend the money to you. 1322 01:06:20,430 --> 01:06:22,890 And therefore, they are just charging you this huge rate, 1323 01:06:22,890 --> 01:06:27,060 just because they are the only possibility. 1324 01:06:27,060 --> 01:06:32,380 And you have two facts when trying to 1325 01:06:32,380 --> 01:06:33,700 evaluate these claims. 1326 01:06:33,700 --> 01:06:36,220 You have two facts which are pulling in slightly different 1327 01:06:36,220 --> 01:06:37,580 directions. 1328 01:06:37,580 --> 01:06:40,640 One fact is that, usually, in a village, you have more than 1329 01:06:40,640 --> 01:06:42,270 one moneylender. 1330 01:06:42,270 --> 01:06:44,580 You could have at least like four or five moneylenders, 1331 01:06:44,580 --> 01:06:47,730 which are like the shopkeeper and then the guy 1332 01:06:47,730 --> 01:06:50,170 who has a big land. 1333 01:06:50,170 --> 01:06:54,060 And two or three people like that will be moneylenders. 1334 01:06:54,060 --> 01:06:57,580 So in principle, there is competition between them. 1335 01:06:57,580 --> 01:07:02,420 However, you don't see people switching. 1336 01:07:02,420 --> 01:07:06,120 So people usually stick to the same person. 1337 01:07:06,120 --> 01:07:10,190 So it is not clear in the end. 1338 01:07:10,190 --> 01:07:13,550 Is it a competitive situation, because, in principle, you 1339 01:07:13,550 --> 01:07:14,790 have a choice? 1340 01:07:14,790 --> 01:07:17,640 Or is it a monopoly situation, because, in practice, you 1341 01:07:17,640 --> 01:07:19,430 don't switch? 1342 01:07:19,430 --> 01:07:23,120 So what's your view of how we can try and explain that, by 1343 01:07:23,120 --> 01:07:24,900 just enriching this model just a bit? 1344 01:07:33,648 --> 01:07:36,078 AUDIENCE: Well, I'm not sure how to incorporate this, but I 1345 01:07:36,078 --> 01:07:37,050 can think of two facts. 1346 01:07:37,050 --> 01:07:41,106 First, the person who borrows needs to have some trust for 1347 01:07:41,106 --> 01:07:45,552 the moneylender, in the sense of like the moneylender says 1348 01:07:45,552 --> 01:07:48,516 you have to pay this interest rate and then doesn't raise it 1349 01:07:48,516 --> 01:07:50,986 immediately when you actually go to repay. 1350 01:07:50,986 --> 01:07:53,456 And that requires some costs to establish this 1351 01:07:53,456 --> 01:07:53,950 relationship. 1352 01:07:53,950 --> 01:07:57,408 Then there's also some cost to switching, again, to establish 1353 01:07:57,408 --> 01:07:58,890 this relationship with another moneylender. 1354 01:07:58,890 --> 01:08:01,456 But there might be the trade-off that you hear, from 1355 01:08:01,456 --> 01:08:03,151 other people, that the other moneylender charges 1356 01:08:03,151 --> 01:08:05,960 significantly lower rates or something like that. 1357 01:08:05,960 --> 01:08:06,970 PROFESSOR: Right. 1358 01:08:06,970 --> 01:08:09,490 So if evaluate on the cost of switching-- yeah? 1359 01:08:09,490 --> 01:08:12,168 AUDIENCE: Didn't you also say that the c would decrease if 1360 01:08:12,168 --> 01:08:13,386 you stayed with the same moneylender? 1361 01:08:13,386 --> 01:08:16,308 Because they don't need to recheck you out. 1362 01:08:16,308 --> 01:08:19,230 So in the future, they can charge you the lower rate 1363 01:08:19,230 --> 01:08:21,670 because of this. 1364 01:08:21,670 --> 01:08:21,830 PROFESSOR: Exactly. 1365 01:08:21,830 --> 01:08:22,992 So there could be. 1366 01:08:22,992 --> 01:08:26,970 You see, this cost of switching, part of it is the 1367 01:08:26,970 --> 01:08:29,310 guy trying to figure out who you are. 1368 01:08:29,310 --> 01:08:33,990 So we can think a part of the c as being paid 1369 01:08:33,990 --> 01:08:34,950 once and for all. 1370 01:08:34,950 --> 01:08:37,790 And then maybe you're paying c again every time you borrow. 1371 01:08:37,790 --> 01:08:42,439 But a part of the c might be, maybe, paid once and for all. 1372 01:08:42,439 --> 01:08:50,210 Now, it means that, if you want to switch, you would need 1373 01:08:50,210 --> 01:08:53,300 pay this c again. 1374 01:08:53,300 --> 01:08:56,290 So number one, that would mean that you would pay a higher 1375 01:08:56,290 --> 01:08:57,310 interest rate. 1376 01:08:57,310 --> 01:09:01,939 Number two, on the other hand, the lender, to whom you are 1377 01:09:01,939 --> 01:09:05,029 coming, he's going to wonder about, why is it 1378 01:09:05,029 --> 01:09:06,789 that they are switching? 1379 01:09:10,990 --> 01:09:14,260 If the c has been paid, once and for all, you should want 1380 01:09:14,260 --> 01:09:16,300 to stay with your moneylender. 1381 01:09:16,300 --> 01:09:19,880 If you're not, it might mean that you have something 1382 01:09:19,880 --> 01:09:22,410 suspicious about you. 1383 01:09:22,410 --> 01:09:26,109 So here, in this model, we have only included a moral 1384 01:09:26,109 --> 01:09:28,950 hazard that is the probability of running 1385 01:09:28,950 --> 01:09:30,520 away with the money. 1386 01:09:30,520 --> 01:09:33,910 But there could be an element of adverse selection. 1387 01:09:33,910 --> 01:09:37,810 There could be some people who are more likely to run away or 1388 01:09:37,810 --> 01:09:39,029 less likely to run away. 1389 01:09:39,029 --> 01:09:42,189 And you just don't know as a lender. 1390 01:09:42,189 --> 01:09:44,189 And you need to investigate. 1391 01:09:44,189 --> 01:09:47,720 Now, if you're trying to switch from an existing 1392 01:09:47,720 --> 01:09:51,550 lender, lending relationship, which, in principle, gives you 1393 01:09:51,550 --> 01:09:55,880 these lower rates, it might be because you have something to 1394 01:09:55,880 --> 01:09:58,270 hide about what your cost is. 1395 01:09:58,270 --> 01:10:02,780 So the resenting moneylender is going to think that you are 1396 01:10:02,780 --> 01:10:05,100 a high risk kind of a guy. 1397 01:10:05,100 --> 01:10:07,350 So he's either going to spend even more effort checking you 1398 01:10:07,350 --> 01:10:10,425 out, or he's going to charge you higher rate and lend you 1399 01:10:10,425 --> 01:10:15,210 less money to correspond to the most risky people. 1400 01:10:15,210 --> 01:10:20,160 So because of that, the fact that you are switching, 1401 01:10:20,160 --> 01:10:23,830 because it might signal that you're a bad type, makes it 1402 01:10:23,830 --> 01:10:26,570 even less likely that you'll switch. 1403 01:10:26,570 --> 01:10:31,920 So if we add a layer of like adverse selection. 1404 01:10:31,920 --> 01:10:34,240 You know about yourself than the lender 1405 01:10:34,240 --> 01:10:36,420 knows, which is realistic. 1406 01:10:36,420 --> 01:10:40,450 Then that will make switching unlikely. 1407 01:10:40,450 --> 01:10:44,040 That means that you're stuck in your existing relationship, 1408 01:10:44,040 --> 01:10:49,120 which means that the lender will try to exploit the fact 1409 01:10:49,120 --> 01:10:51,580 that you're stuck into this existing relationship. 1410 01:10:51,580 --> 01:10:55,990 He will say, well, staying with me brings you a surplus. 1411 01:10:55,990 --> 01:10:59,670 I'm going to extract some of that surplus from you, which 1412 01:10:59,670 --> 01:11:01,910 means that, even though there is a lot of competition, 1413 01:11:01,910 --> 01:11:05,140 ex-ante, ex-post, you might be stuck in a one on one 1414 01:11:05,140 --> 01:11:06,890 exploitative relationship. 1415 01:11:06,890 --> 01:11:08,730 So that's why we can have these kind of two things 1416 01:11:08,730 --> 01:11:11,310 together, of a lot of competition and, at the same 1417 01:11:11,310 --> 01:11:14,240 time, this one on one monopoly relationship. 1418 01:11:14,240 --> 01:11:14,670 Yeah? 1419 01:11:14,670 --> 01:11:16,390 AUDIENCE: For all this to hold true, it must be true that 1420 01:11:16,390 --> 01:11:17,620 rates that the different moneylenders 1421 01:11:17,620 --> 01:11:19,230 charge are about equal. 1422 01:11:19,230 --> 01:11:22,025 Because if there was a huge benefit to switching, it might 1423 01:11:22,025 --> 01:11:23,260 out weigh the costs. 1424 01:11:23,260 --> 01:11:23,605 PROFESSOR: Right. 1425 01:11:23,605 --> 01:11:27,210 So it's to a point, it's going to equilibriate. 1426 01:11:27,210 --> 01:11:30,480 So basically, what the moneylender that your are with 1427 01:11:30,480 --> 01:11:33,290 is going to do is that they are going to set the interest 1428 01:11:33,290 --> 01:11:38,660 rate just low enough that switching is not worth it. 1429 01:11:38,660 --> 01:11:43,070 But that means they are going to start making a profit on 1430 01:11:43,070 --> 01:11:45,680 the people in which they have a relationship. 1431 01:11:45,680 --> 01:11:50,640 Because now, they know that they can do better than just 1432 01:11:50,640 --> 01:11:52,310 charging the break even rate. 1433 01:11:52,310 --> 01:11:56,980 Because there is this gain of thing with them, which is a 1434 01:11:56,980 --> 01:11:57,950 very big gain. 1435 01:11:57,950 --> 01:12:02,720 Because the other people would be quite suspicious of you. 1436 01:12:02,720 --> 01:12:04,050 And you're exactly right. 1437 01:12:04,050 --> 01:12:07,000 Everybody will end up charging the same rates in a village, 1438 01:12:07,000 --> 01:12:08,100 in equilibrium. 1439 01:12:08,100 --> 01:12:11,040 And this rate will be higher than the rate that they would 1440 01:12:11,040 --> 01:12:14,620 have been charging in the absence of this 1441 01:12:14,620 --> 01:12:15,870 difficulty to switch. 1442 01:12:19,260 --> 01:12:24,215 So that's why you could have like this combination of, you 1443 01:12:24,215 --> 01:12:26,420 know, they are kind of running their business in a difficult 1444 01:12:26,420 --> 01:12:29,220 situation, and they are actually taking advantage of 1445 01:12:29,220 --> 01:12:29,760 their clients. 1446 01:12:29,760 --> 01:12:30,248 Yeah? 1447 01:12:30,248 --> 01:12:32,200 AUDIENCE: I know that one of the articles that I read-- 1448 01:12:32,200 --> 01:12:35,616 I think it was [INAUDIBLE] professor that proposed it or 1449 01:12:35,616 --> 01:12:38,560 proposed-- or maybe it was the Finacial Times-- 1450 01:12:38,560 --> 01:12:42,054 creating this central-- at least in India-- 1451 01:12:42,054 --> 01:12:46,615 MFI, like a database of all the loans, of some way to see 1452 01:12:46,615 --> 01:12:49,390 everybody's indebtedness, across the board. 1453 01:12:49,390 --> 01:12:52,670 Wouldn't this help minimize the cost of switching? 1454 01:12:52,670 --> 01:12:55,370 PROFESSOR: Right. 1455 01:12:55,370 --> 01:12:58,810 This kind of central database, credit registry, similar to 1456 01:12:58,810 --> 01:13:01,450 what we have in the US, that would help. 1457 01:13:01,450 --> 01:13:04,910 Because that would exactly solve this problem. 1458 01:13:04,910 --> 01:13:07,350 Because then the new moneylender would know exactly 1459 01:13:07,350 --> 01:13:08,430 what is your history. 1460 01:13:08,430 --> 01:13:09,790 The thing is the moneylenders are not going 1461 01:13:09,790 --> 01:13:11,150 to enter into that. 1462 01:13:11,150 --> 01:13:15,100 So that is something that the microfinance agencies could do 1463 01:13:15,100 --> 01:13:16,340 for themselves. 1464 01:13:16,340 --> 01:13:20,250 But that's something that moneylenders won't do. 1465 01:13:20,250 --> 01:13:22,390 There is sort of one more fact that is going to push the 1466 01:13:22,390 --> 01:13:26,680 interest rate up that is less benevolent from the point of 1467 01:13:26,680 --> 01:13:27,930 view of the moneylender. 1468 01:13:33,090 --> 01:13:35,770 The formal institution we already discussed. 1469 01:13:35,770 --> 01:13:38,450 The formal institutions are far away. 1470 01:13:38,450 --> 01:13:40,540 The formal institutions don't have a 1471 01:13:40,540 --> 01:13:43,690 means to threaten people. 1472 01:13:43,690 --> 01:13:51,030 The formal institutions, even if they were able to get 1473 01:13:51,030 --> 01:13:54,770 people to repay, they might not like headlines of farmer's 1474 01:13:54,770 --> 01:13:56,350 suicide and all that. 1475 01:13:56,350 --> 01:13:58,590 So that doesn't put them in a very favorable 1476 01:13:58,590 --> 01:14:03,100 situation to lend. 1477 01:14:03,100 --> 01:14:08,800 So these difficulties in the credit market explain why, 1478 01:14:08,800 --> 01:14:13,310 despite the effort, the formal institutions have been 1479 01:14:13,310 --> 01:14:19,450 relatively unable to lend to the poor until now and explain 1480 01:14:19,450 --> 01:14:22,630 why people have access to all of these moneylenders at these 1481 01:14:22,630 --> 01:14:24,320 very high rates. 1482 01:14:24,320 --> 01:14:28,210 The genius of microcredit is to introduce an institutional 1483 01:14:28,210 --> 01:14:32,060 form that solves a lot of these problems without 1484 01:14:32,060 --> 01:14:35,350 resorting to breaking people's kneecaps. 1485 01:14:35,350 --> 01:14:38,270 So what microfinance does-- and you're going to see that 1486 01:14:38,270 --> 01:14:40,070 in much more detail next week. 1487 01:14:42,920 --> 01:14:44,870 What are the key elements of the model of microfinance? 1488 01:14:47,624 --> 01:14:50,079 AUDIENCE: You borrow in groups, [INAUDIBLE]. 1489 01:14:53,030 --> 01:14:54,390 PROFESSOR: And what is the group doing? 1490 01:14:54,390 --> 01:14:55,990 What is the value of the group? 1491 01:14:55,990 --> 01:14:57,900 See, if we put it in the context of the model, what is 1492 01:14:57,900 --> 01:14:59,210 the value of the group? 1493 01:14:59,210 --> 01:15:02,268 AUDIENCE: So they insure payment for each other. 1494 01:15:02,268 --> 01:15:05,130 So if one person defaults, the others can cover the loan. 1495 01:15:05,130 --> 01:15:05,610 PROFESSOR: Exactly. 1496 01:15:05,610 --> 01:15:08,014 So where does it play out in normal debt, in term of the 1497 01:15:08,014 --> 01:15:08,610 parameters? 1498 01:15:08,610 --> 01:15:11,070 AUDIENCE: It decreases the run away risk. 1499 01:15:11,070 --> 01:15:13,830 PROFESSOR: It decreases the run away risk. 1500 01:15:13,830 --> 01:15:15,656 It could also decrease the fixed cost, because you know 1501 01:15:15,656 --> 01:15:16,780 people are not running away. 1502 01:15:16,780 --> 01:15:20,480 The cost of the monitoring, it's not that it decreases . 1503 01:15:20,480 --> 01:15:22,950 Someone still needs to pay for the monitoring. 1504 01:15:22,950 --> 01:15:24,240 But it is the other people. 1505 01:15:24,240 --> 01:15:25,950 It's not the bank anymore. 1506 01:15:25,950 --> 01:15:28,270 So there is no multiplier. 1507 01:15:28,270 --> 01:15:30,090 The cost of the monitoring reduces. 1508 01:15:30,090 --> 01:15:33,480 And therefore, because of the multiplier effect, you can 1509 01:15:33,480 --> 01:15:36,460 reduce the interest rate quite a bit as a function of that. 1510 01:15:36,460 --> 01:15:39,170 So that's one, group lending. 1511 01:15:39,170 --> 01:15:43,175 What else is microcredit doing? 1512 01:15:43,175 --> 01:15:45,610 AUDIENCE: I know two of the functions they have, like 1513 01:15:45,610 --> 01:15:47,558 certain payment schedules and steps. 1514 01:15:47,558 --> 01:15:51,210 And typically, they assign you some sort of consultant or 1515 01:15:51,210 --> 01:15:54,619 someone who helps you discuss business plans 1516 01:15:54,619 --> 01:15:55,350 and stuff like that. 1517 01:15:55,350 --> 01:15:58,050 So your default risk is also lower, because you'll make 1518 01:15:58,050 --> 01:15:59,780 smarter use of it. 1519 01:15:59,780 --> 01:16:00,190 PROFESSOR: Right. 1520 01:16:00,190 --> 01:16:03,130 So they can reduce the default rate like that. 1521 01:16:03,130 --> 01:16:06,070 The other thing you said is that they have this very 1522 01:16:06,070 --> 01:16:07,700 regular schedule. 1523 01:16:07,700 --> 01:16:10,680 So they try and reduce the administrative cost by making 1524 01:16:10,680 --> 01:16:12,920 all of the products the same. 1525 01:16:12,920 --> 01:16:15,410 So the typical microcredit loan is you take a loan, and 1526 01:16:15,410 --> 01:16:19,660 then you reimburse it in 52 installments of the same size. 1527 01:16:19,660 --> 01:16:25,000 So that means one guy can handle a vast number of 1528 01:16:25,000 --> 01:16:28,290 repayments in just one round. 1529 01:16:28,290 --> 01:16:30,990 They basically go from village to village, meet with the 1530 01:16:30,990 --> 01:16:33,800 entire center, which is usually a combination of these 1531 01:16:33,800 --> 01:16:36,610 groups, and take all the money at once and go. 1532 01:16:36,610 --> 01:16:40,040 And so that reduces the c, if you want, the cost, the fixed 1533 01:16:40,040 --> 01:16:42,320 cost of administering the loan, which, again, can be 1534 01:16:42,320 --> 01:16:45,890 passed to the borrower. 1535 01:16:45,890 --> 01:16:48,746 AUDIENCE: As a result of that as well, you're making a 1536 01:16:48,746 --> 01:16:53,520 relationship with the borrower. 1537 01:16:53,520 --> 01:16:56,889 You build a relationship of trust and the incentive is to 1538 01:16:56,889 --> 01:17:00,638 want to pay back [INAUDIBLE]. 1539 01:17:00,638 --> 01:17:04,550 PROFESSOR: Right, another thing that microfinance has is 1540 01:17:04,550 --> 01:17:08,830 that they are lending one loan, that's usually small at 1541 01:17:08,830 --> 01:17:10,820 the beginning, and then they increase it and then they 1542 01:17:10,820 --> 01:17:12,650 increase it and then they increase it. 1543 01:17:12,650 --> 01:17:14,440 And that's supposed to give people incentive 1544 01:17:14,440 --> 01:17:15,840 to continue to repay. 1545 01:17:15,840 --> 01:17:18,800 Although one has to wonder when that stops. 1546 01:17:18,800 --> 01:17:20,510 Because, eventually, they might consider that they have 1547 01:17:20,510 --> 01:17:22,830 now built up enough that they can just default with the 1548 01:17:22,830 --> 01:17:24,070 entire money. 1549 01:17:24,070 --> 01:17:28,290 But over the whole beginning of relationship, you are going 1550 01:17:28,290 --> 01:17:31,930 to benefit from this incentive to continue repaying. 1551 01:17:31,930 --> 01:17:34,180 Because now the incentive is not only I'm going to break 1552 01:17:34,180 --> 01:17:36,410 your kneecap if you don't repay, but it's I'm not going 1553 01:17:36,410 --> 01:17:39,980 to lend you another loan. 1554 01:17:39,980 --> 01:17:46,440 So making product very standardized makes it to 1555 01:17:46,440 --> 01:17:49,800 available to hire people, who are less well known, going 1556 01:17:49,800 --> 01:17:51,990 straight to the villages, using the group loans. 1557 01:17:51,990 --> 01:17:55,840 All of that reduces the cost of lending, which, because of 1558 01:17:55,840 --> 01:17:57,480 the multiplier, is passed to interest. 1559 01:17:57,480 --> 01:18:00,800 And of course, they are often nonprofit or even subsidized, 1560 01:18:00,800 --> 01:18:03,360 which again helps, with regard with the 1561 01:18:03,360 --> 01:18:05,720 discussion we had before. 1562 01:18:05,720 --> 01:18:07,190 So I'm going to leave it here for now. 1563 01:18:07,190 --> 01:18:10,120 And then, next time, we're going to get much more into 1564 01:18:10,120 --> 01:18:11,370 detail about microcredit.