David Puglielli
Special Project

The World Bank and Microfinance:
An elephant trying to build a bird nest

The merits of the small-scale sector in the context of less-developed countries (LDCs) are both logically sound and have been empirically proven in the literature. Micro-enterprises take advantage of the abundant labor supply characteristic to LDCs to better maximize the capital/labor function. However, microenterprises are an exceptional form of business which is reflected in their unique fiscal needs. Those special needs are usually classified as micro-loans.

Small businesses take on markedly more risk than larger enterprises usually with little collateral. For this reason, standard credit sources (funds from commercial or development banks (are customarily inaccessible to these firms in a form conducive to efficient productive investment, or worse, credit is unavailable altogether. The capital starvation of small industries is a economic development tragedy.

Governments and international organizations are only now realizing the advantages of providing micro-enterprises with credit. Financial institutions have been created to alleviate the financial repression of small industries such as Grameen Bank of Bangladesh, but the major lenders to microenterprises are informal credit institutions.

Micro-lending is a development strategy based in neo-classical theory of capital and growth rates. Presently, LDCs financial systems are inefficient. In LDCs, the credit systems generally ration credit in lump sums to the best credit risks. This activity is commonly highly adverse to small business, and in LDCs (where small business best uses available production factors (a low-cost macroeconomic growth method is artificially hindered.

Therefore, it could be argued that multilateral organizations should be petitioned to remedy the credit market failure. In my investigation I will evaluate the potential of the World Bank as an instrument in microenterprise development. There is a conspicuous absence of literature on World Bank involvement in microfinance, though I believe that the World Bank's role -an organization born in the ideology of post-war planned development theory -should be defined in this new market driven area of economic development.

Post-war Development

Modern development economics began during the post-war era as a complement to the growing political independence in Asia, Africa and Latin America. The post-war development economists heeded pioneer classicists' -Smith, Malthus and Ricardo - teachings; placing emphasis on capital, population and what Adam Smith termed the "progress of opulence," (Robbins 1968) which states that once the growth process has begun, it is self-reinforcing. However, early development economists went beyond their classical and neo-classical roots and investigated policy, implemented by an active state, that could direct or accelerate the growth process.

Policy-run development dominated the 50s and 60s and emphasized almost solely GNP per capita growth through capital accumulation and industrialization based on import substitution. Additionally, a general distrust of markets and impending market failure led development economists to believe that planned investment was the most auspicious path toward economic growth. Robust growth models, centered on industrialization, surplus labor utilization, import substitution all controlled in a centrally planned environment, permeated development theory.

Policy makers did not need to condone economists' theories to move toward planned industrialization. The political and ideological environment of the time provided the impetus toward centralization. Nonetheless, many economic suppositions during the 50s and 60s were in line with the predominant ideologies, therefore, the political economy had much theoretical backing. For the post-war development economists, though they clung to the efficacy market forces, believed in economic obstacles to development that could only be overcome by well-formed policy, especially policy geared toward rapid industrialization.

The common thought by post-war development economists that for successful industrialization to take place, a less developed country must plan the framework of development much like the planned growth of a large firm (Rosenstein-Rodan, 1943). The important components of the planned growth is "skilling" the labor supply and large-scale planned industrialization. Part of the planning was to develop complementary industries within the country, and thus, reduce the risk of not being able to sell goods produced. Additionally, indivisabilities of inputs, processes, or outputs require countries to develop industries to optimum scale hence they may be sustainable. Called the "big push" by Rosenstein-Rodan who believed that no one industry might be profitable on their own. Promotion of several complementary industries, however, causes demand increases for the output of all the industries involved. Scale optimization a necessary mechanism to break out of the "low level equilibrium trap" created by a laissez-faire system (Nelson, 1956). Such a trap was seen by Nelson as a type of market failure where a LDC's macroeconomy reaches a market equilibrium but demand meets suply only at the subsistance level. Hirschmann (1958) too believed that markets had many shortcoming when it came to development policy. He endorsed unbalanced growth; taking advantage of forward and backward linkages. Whereby, the promotion of certain industries could expediate the growth of others.

Once industrialization takes place, the homogeneity of an agriculturally based country is lost. The Lewis (c1984) dual-sector model probes the interactions between two economic sectors -the informal and formal. Lewis contends the ultimate question for a country's development is how the modern sector expands while the traditional sector contracts.

In the language of Lewis, a country's economy is comprised of the "capitalist" sector and the "noncapitalist sector." The capitalist sector is defined as that part of the economy that uses reproducible capital, pays the capitalist for the use thereof and employs labor for profit-making purposes. Production in the capitalist sector does not just include manufacturing; it can include any agent of production that hires labor and sells output for profit. What Lewis delimits as the non-capitalist sector -traditional or informal sector -is that part of the economy that does not use reproducible capital and does not hire labor for profit. In this largely subsistence sector, output per capita is usually much lower because of the lack of labor enhancement by use of capital. Lewis depicts the traditional sector as chiefly agricultural, thus, giving the impression that the sector is composed of subsistence farming where the average output is zero.

Lewis construes in his dual sector model as a fundamental relationship between the two sectors. As the capitalist sector expands, it draws labor from the non-capitalist sector. According to the model, the informal sector has an virtually unlimited unskilled labor supply, making labor extremely elastic at a given wage above the subsistence level. Given the large pool of unskilled labor, and consequently the near-perfect elasticity of labor supply, industry can expand or new industry can be created without encountering any shortage of unskilled labor until the point where surplus labor from the informal sector is absorbed.

The Resurgence of Neo-Classism

Though the development community was enthralled with planned development during the 50s and 60s, the 70s and 80s were marked by a resurgence of neoclassical economics. Planned economic development in many countries had either had been proven ineffective by the 70s or had unforeseen negative effects due to policy-induced distortions. The policy distortions caused non-market failures in many countries which led to the critique of comprehensive centralized development controls. Price distortions had to be removed in developing countries, and thus, the market took on a more prominent role in development economics.

Though there has been a resurgence of neoclassicism in the development community, the debate over the role of some centralized body -public or private -in guiding development, is to present, unresolved. Policy prescriptions for development range from the kind of central planning found in the 50s and 60s to completely market driven development strategies (White, 1992). However, learning from the past, government and private multilateral agencies are trying to keep the market in mind, but they have yet to shed completely their non-market operations (in Perkins and Roemer, 1991).

The World Bank acts in a non-market setting and chooses development projects and funds them though what the World Bank calls Structural and Sectoral Adjustment Loans (Harrigan and Mosley, 1991). The validity of the projects or programs, however, are not market determined. Non-market activity by the World Bank can have ambiguous or even negative effects on the macroeconomy (White, 1992). While certain industries or sectors backed by World Bank aid fair well the non-market nature of the aid may crowd out most efficient market constrained activity in the private sector. Additionaly, private sustainable investment is an importanat fator in LDC development. Aid that crowds out private market activity in both production and investment is detrimental to macroeconomic growth. This micro-macro paradox explains why of 245 projects evaluated by the World Bank, 85 percent of the World Bank's projects faired well, but the countries in which the projects were implemented, the macroeconomy was not proven to be better off (White, 1992).

Microenterprise and the Informal Sector

An entity in the macroeconomy never conceived by either the fathers of the World Bank nor Arthur Lewis in his dual sector model is the microenterprise. Characterized by their flexibility and rapid response to growth opportunities, small-scale enterprises can promote economic growth and equality. They operate in the informal sector thereby contradicting Lewis' assumption that activity in the informal sector is homogeneous. Unlike large-scale industry -concentrated in urban areas where services are more readily available - microenterprises can be found throughout a country. Therefore, microenterprise can be a dynamic vehicle for indigenous participation in manufacturing (Parker, Riopelle and Steel, 1995).

Microenterprise activity has had a profound effect on a country's economic growth since the turn of the century. However, until recently, policy makers' belief in trickle-down strategies for development have greatly underplayed the importance of microenterprise. The promotion of microenterprises in developing countries is justified in their abilities to foster economic growth, alleviate poverty and generate employment (Livingstone, 1991).

Small-scale industries rely more on labor than capital intesive production, thus employ more efficient utilization of production factors as compared to large industries by exploitation of abundant unskilled labor. Allocation of savings for capital investment advances capital accumulation within the informal sector. Additionally, producing a competitive environment, in which, national entrepreneurs can become better equipped to compete with large and inefficient public or foreign industries (Balkenhol, 1990).

Parameter 1: Size Business Defined by number of Employees

Argentinaless than 1516-5051-200above 200
Bolivialess than 55-4950-99above 100
Brazilless than 1920-99100-499above 500
Chileless than 1-910-4950-200above 200
Colombialess than 1010-4950-200above 200
Ecuadorless than 1010-4950-100above100
Guatemalaless than 2-85-1920-50above 50
Mexicoless than 1516-100101-250above 250
Peruless than 55-1920-200above 200
Uruguayless than 45-1920-99above 99
(Ruiz-Durn, 1995)

As defined by the parameters in the tables above and below, we can see, by the number of small-scale enterprises alone, that they are strateic to economic development. In Colombia, out of 94 thousand industrial enterprises, 89 percent are micro, 6 percent are small, 4 percent are medium and 1 percent are large businesses. Of the 465 thousand enterprises in Chile, 83 percent are micro, 14 percent are small, 1.2 percent are medium and 1.5 percent are large; Brazil has 186 thousand industrial enterprises, of which, 82 percent are micro, 13 percent are small, 4 percent medium and 1 percent large; in Peru out of 159 thousand private institutions, 87.5 are micro, 10.8 percent are small, 0.5 are medium and 0.1 percent are large. Out of 11 thousand industrial enterprises in Bolivia, 87.5 percent are micro, 8.3 percent are small, 2.3 percent are medium and 2.3 percent are large; Mexican enterprises number 266,033, of which, 92 percent are micro; 6 percent are small, 1 percent are medium and 1 percent are large (Ruiz-Durn, 1995).

Parameter 2: Size Business Defined by Worth





less than 200

less than 100





above 12800

BrazilNet Incomeless than 130

130-13001300-4000above 4400

less than 6060-600600-1200above 4000
EcuadorAssets w/out land and buildings

less than 6

less than 52


above 1200

GuatemalaEquity**less than .34-5.9

up to 12711up to 33898above 33898
MexicoSalesless than 180

180-18001800-20000above 1000


less than 60

less than 20





above 350
(Ruiz-Durn, 1995)

Though microenterprise plays a major role in the macroeconomies of LDCs, they have specific needs for credit. The formal financial sector's lending in these countries are not conducive to small-scale, dynamic, and heterogeneous activities of the informal sector. More detrimental to small-scale enterprise -and the entire private sector -is the custom of credit rationing practiced by LDCs which starves the private sector of much needed capital.

Credit Rationing

Ronald McKinnon in Money, Interest, and Banking in Economic Development analyzes the accumulation of non-capital assets (such as commodity inventories) by micro-enterprises. In the McKinnon "complementary hypothesis" model, microenterprises must accumulate a great deal of non-capital assets before productive investment can take place. The considerable investments in non-capital assets causes lumpy investments in physical capital. Non-captital assets lead to lumpy investment because of they are generally not directly convertable to physical capital. Therefore, commodity inventories, or the like, must be accumulated before working capital can be employed. McKinnon considers non-capital assets such as commodity inventories to be the "least-cost method of building up these non-capital assets". However, lumpy investment in physical capital and the costs of inflation hedges (such as storage costs) cause negative returns (Burkett and Vogel, 1992).

McKinnon further argues that the only way to increase the supply of credit, and thus minimize the afore mentioned externalities, is through "financial liberalization" (Burkett and Vogel, 1992). The governments of LDCs typically impose controls on the loan and deposit rates of commercial and development banks. McKinnon and other development economists oppose such counter-market rate regulations which lead to what McKinnon calls "financial repression" (in Buffie, 1991).

The supposition is that binding interest controls cause wide dispersion in the "marginal efficiency of investment" across firms (Tybout, 1983). The dispersion in efficiency is attributable to the financial institutions' positions of rationing credit to the best credit risks so that particular financial institution may be sustainable. In the case of government intermediaries, rationing takes place according to fiscal pressures (as in private financial institutions), corruption or promotion of 'priority' sectors which are generally capital intensive industries (Buffie, 1991).

Most importantly, credit rationing creates non-price mechanisms for screening borrowers by lenders relies on imperfect information (Blinder and Stiglitz, 1983). Lender in the formal context are not privy to the type of information that would determine a good credit risk in the informal sector. Microenterprises do not have formal "reputation capital"1 necessary to procure credit. Knowing that the a small textile industry has historically been a good risk does not tell much about the female onion merchants has just as much potential in the marketplace. In this case of informal sector industries, the agents ar not only in to separate industries, but the microeconomies and social contexts in which they operate may also be completly different. Often this imperfect information gives rise to strong incentives such as credit histories, collateral, lengthy loan applications for borrowers not to default. Credit histories are and an attempt to both discourage defaults and gain specific knowledge of a firm's individual risk. Often, credit histories link specific borrowers to lenders, and credit is made inaccessible for a class of potential borrowers, like microentrepreneurs, that are viewed as risky. Therefore, credit needs go unmet, and capital starvation -biases against small-scale enterprise -occurs.

Formal Financial Sector

The financial sector of any given economy is crucial to the development of that country. The financial sector has the power to select who can borrow, thereby, determines where growth will occur. Similarly, growth in the production sector will strengthen the financial sector. A well-developed financial sector matches capital to varying risk/return endeavors. However, a country with a less developed financial structure will likely restrict the access to finance by micro-enterprises and other risky borrowers.

The main financial institutions in most LDCs are commercial banks (UNCTAD: Trade and Development Board, 1995). These institutions make primarily short-term loans, and where inflation is a problem the length of the loan is shortened still.

The biggest downfall of commercial banks is its inability to finance microenterprise. Though banks can charge a higher interest rate to microenterprises, the higher rates do not cover the risk and administrative costs of lending to these borrowers. Not that the microentrepreneur borrowers pose more of a real credit than formal borrowers; the problem lies in the lack of reputation capital informal firms can have in the formal sector.

Development banks attempt to compensate for the failed capital market dominated by the commercial banks. Governments of LDCs that have established development banks to allocate multi-lateral donations and set-aside government revenues to develop selected sectors of the country's macro-economy.

Few development banks have had success in lending to microenterprises, most have not proven themselves to be financially sustainable. Development banks, for the majority, do not have sufficient levels of profitability to cover operating costs (UNCTAD: Trade and Development Board, 1995). Limited resources and attempts to raise profitability have pushed development banks to finance large enterprises.

Another circumstance that constrains development bank activity with microenterprises is the highly centralized structure of development banks. The banks do not have the regionalized network of branches necessary to respond quickly to the demands of micro-enterprises. They are usually not at the grass-roots level and are subjuct to the inertia inherent to such a bureaucracy.

Ruiz-Durn, 1995)

Additionally, loan requests are often cumbersome and slowly processed, thereby further hindering the effectiveness of development banks. In response, LDCs have established financial institutions like KUPEDES progam of the government-owned Bank Rakyat in Indonesia to provide credit exclusively to microenterprise that work in conjunction with development banks and international organizations like the IMF and World Bank. However, even with such deliberate purpose, such financial institutions fall into the same response traps as development banks such as requiring collateral and cumbersome paperwork (UNCTAD: Trade and Development Board, 1995 and Berger, 1989). Microenterprises, generally rejected from formal credit, must find other was to finance capital accumulation.

The Informal Finacial Sector

Informal Credit Markets (ICMs) (agencies not regulated or monitored by banking authorities( account for much of the business credit in developing countries (Timberg and Aiyar, 1984). ICMs work alongside the formal financial system, but ICMs are generally more prolific in poorer countries. In LDCs the formal capital markets are not well developed, and therefore the informal financial sector extends credit and mobilizes savings (Kessler and Meghir, 1989).

Financial dualism affects economic development through the dicotomization of resource accumulation and allocation. Disparity between sectors is created with respect to the mobilization and allocation of resources. The result is a growth-rate differential between sectors (Dowrick and Gemmell, 1991).

ICMs (characterized by flexibility and speed, but also by high costs of transactions (respond to the needs of those segments of the population excluded from the formal sector or those that prefer the responsiveness of ICMs. Thus, ICMs' clientele are composed of those borrowers excluded from the formal sector or those who do have access to formal financing but want to take advantage of an ICMs responsiveness or those who want to better integrate themselves with their community. For the most part, however, small-scale and particularly microenterprises comprise the majority of borrowers in the informal credit market (Timberg and Aiyar, 1984). Small businesses or new businesses present high credit risks often with very little (or zero( collateral.

However, the cost of informal finance is exorbitantly high (Timberg and Aiyar, 1984).

Figure 1. Real Interest Rates Per Annum in Selected Countries, 1975
CountryInformal SectorFormal Sector
Ivory Coast1456
Sierra Leone60-3
Republic of Korea495
Costa Rica204
Sri Lanka20-1
Steve Haggblade, Carl Liedholm and Donald Mead. "The Effects of Policy and Policy Reforms on Non-Agricultural Enterprises and Employment in Developing Countries: A Review of Past Experiences," in Stewart et al., The Other Policy: The Influence of Policies on Technology Choice and Small Enterprise Development (London: IT Publications, 1990).

The rate differential shown above is justified by the fact that ICMs take on riskier projects and the opportunity cost of funds is higher for them.

Despite the absence of governmental or any regulatory framework, and minimum collateral requirements, ICMs exhibit lower default rates than the formal-sector credit institutions. The proximity of the ICMs to their clients enables them to monitor their clients' whereabouts and business activities. In addition, since ICMs are often community organizations, peer pressure plays a major role in the low default rate of ICMs. However, ICMs are poorly financed themselves and lack the financial capabilities of the formal sector.

Any discussion about economic development should begin with the simple idea -there are no quick fixes. In many LDCs, the preferred development route is through large capital intensive projects -steel mills, hydroelectric plants -that bring the promise of immediate economic sustainability. As a result, those LDCs look past the kind of grass-root economic activity that have a comparative advantage in capital poor, unskilled labor rich countries.

World Bank Impact on Microenterprise

Much of the development community has accepted small-scale enterprise as a viable instrument for achieving sustainable growth (Mead, 1991). However, the development community has not agreed upon the appropriate method of microenterprise promotion. Microenterprises, though usually operating in the informal market environment, have constraints -access to formal credit and foreign goods -that are imposed by forces outside of the indigenous sector. Such forces are highly influenced by governments and multilateral aid institutions.

The lack of capital is the largest constraint to microenterprise development. The high cost of capital deters expansion of microenterprise economic activity. The capital needs of microenterprises are not large, but the inability of microenterprises to carry adequate stocks of raw materials and inventory cause discontinuities in production and sales which, in turn, brings about low productivity (Tybout, 1983).

The capital constraints to microenterprise development arises because of the inability of the microentrepreneur to provide bankable guarantees. Such credit constraints are the result of a credit market failure. Thus, it would follow that non-market agencies -the World Bank -which can operate without such tight market contraints and guarantee loans, could have a positive effect on microenterprise development. However, this is not the case.

The non-market nature of the World Bank has potentially ineffective or even disastrous effects. Presently, the World Bank is mobilizing resourses to fund its Consultative Group to Fund the Poorest (CGAP) program. There is hope the World Bank will draw upon the expertise of institutions that have specicialized in microfinance (Durham, 1996). Historically, the World Bank was born and has operated in the formal lending context. Therefore, its immense size and centralized organization that was so revered during its conception is made obsolete in the fast-paced and highly dynamic world of microfinance.

The problem of knowledge is the primary constraint of the potential World Bank's microlending potential. The World Bank has no way of achieving the kind of responsiveness the informal credit market needs. This is the very concern of many in the developement community and leads them to ask, "can an elephant build bird nests?" Lending in the informal context make decisions like, who to lend to and at what interest rate, very difficult for the World Bank to answer. Additionally, there is always the danger of crowding out private investment (Durham, 1996).

However the largest detriment to World Bank microlending programs is its lack of regionalization necessary for both market and non-market operations. Informal lenders are and interactive part of the social and economic community in which they are lending. Therefore, they have access to non-formal credit histories and risk assessment information. Also, disbursement of credit and market response of informal credit agents is as dynamic as the needs of the community in which they reside. The World Bank has none of these resources available to them, so any microlending program will be simply educated guesswork.

Primarily, lending to women is not only a feasible track toward development, but one that has some empirical backing in the Grameen Bank and other lending models. The development community has long recognized that women have less access to credit than men in many developing countries (Valentine, 1995). Often, investing in women will bring about a higher return in both the enhancement of human and physical capital than investing in men. However, women have more difficulties obtaining credit than men in many LDCs. This is evident when we see that women's participation on formal, small-scale enterprise lending program rarely exceeds 20 percent. The KUPEDES program in Indonesia granted only 25 percent of its loans to women; even though women are 60 percent of the borrowers in the smaller village bank program that served as its model (Berger, 1989). Additionally, the project called the Urban Small Enterprise Fund (UEF) succeded in loan to only 16 percent women (Buvinic and Berger, 1990).

Many existing microlending programs in the informal sector have included a high participation rate by women even when women are not specifically targeted. Others in the formal sector have only a few female participants (Berger, 1989). Such a disparity raises question about what kind of lending programs, mechanisms or institutions are most workable to meet the needs of women in LDCs.

Women are active in the developing countries' market economy. Their participation rate are steadily increasing, while the growth of the male labor force is slowing or shrinking (Berger, 1989). Women's registered labor force participation is least in the Middle East and North Africa and relatively high in the Caribbean, Southern and Western Africa, and in East Asia. However, even where women participate less in the formal sector, they are highly visible in the informal sector (Berger, 1989).

Women in the informal sector usually carry out several microbusinesses and/or agricultural activities simultaneously or seasonally (Berger, 1989). Given the amount of resources with which these women operate, frequent shifts among activities could cause greater economic stability for both the women and their microenterprises through constantly seeking out activities that yield a positive return. Women, in this kind of situation, need credit. Credit facilitates productivity through allowing the women to purchase more inputs to increase output (If demand dictated), keep inventories either to hedge against inflation or change in individual commodity price, invest in capital inputs or labor inputs (wage labor, machines, buildings), and sell on credit which all allows women to increase their productivity. However, the characteristics of formal bank credit are often inappropriate for the needs of female microentrepreneurs.

Women are especially adverse to formal credit because of social and economic inequities. In some LDCs where the society is highly patriarchal, women are required to have her husband or some other male relative cosign for a loan. In other cases, where women tend to be small borrowers, the formal credit is not available below a certain level due to administrative costs. More insidiously, the case may be outright gender discrimination. Bank employees may simply deny credit to any female. These problems may also be compounded when considering specific country or social contexts where women are less educated or are considered of a lower class than men.

Often in LDCs, poor women work longer than poor men in the same class when both market and household tasks are included (Berger, 1989). Longer work hours considered, a woman's opportunity cost of credit transactions is greater than a man's. If she both works in and out of the home, the time it takes to complete a credit application is a cost either in money or leasure. Therefore, formal credit is biased against women because of the lengthy credit application process found in many formal credit institutions.

Considered one of the most persuasive arguments for female formal credit non-participation is collateral requirement by formal lending agencies. Though a lack of collateral is a problem for many borrowers, the problem is compounded by the widespread custom of registering property in the names of male household members and systems of inheritance that distribute property only to male survivors. The types of property that women might control -like jewelry -are likely not to be accepted by formal credit institutions.

Another barrier to formal credit for women is a general lack of education on the part women -except in Latin America where educational levels between men and women are nearing equality. In Africa, the education levels of women are only 58 percent of those of men, and in South Asia, only 47 percent (Berger, 1989). As a result, women are less able to understand and complete credit applications and financial statement forms that banks require for credit approval. Women may also not have practical knowledge of formal financial institutions or the appropriate loan programs that may give them access to credit.

Additionally, it is not uncommon for a bank to permit only one loan per household, even if the members of that household are engaged in separate business activities (Berger, 1989). Such policies are an obvious guard against fraud, however, in some cases household economic activities are conducted separately. Often, especially in Africa, the women and men keep their income separate with women's income going toward household needs such as clothing anf food. Thus, access to credit is denied even to credit-worthy borrowers. Such a policy compounds women's credit access problems by making their credit activity mutually exclusive with any male member of the household when men already have more access to credit.

Therefore, the World Bank could lend to only women and try to rid LDCs of gender bias in credit allocation. Conceivably, such a policy is possible. Non-governmental organizations such as Women's World Banking have taken on the mission of alleviating lending primarily to women. Women do present a chance for economic development and are the the victims of market failure, but the question of which women to lend to and at what interest rate remaines unanswered.

Interest rates are another policy issue the World Bank would have to determine. Commercial banks will often not lend to microenterprises because of artificially low interest rates their inability to determine the risk involved with lending to any particular microenterprise. However, the World Bank is not privy to any more information than the commercial banks. Because the informal sector is heterogeneous and has varying levels of risk attached to different microentrepreneurial activities, setting the correct interest rate for an agency such as the World Bank is nearly impossible. Agencies like the World Bank operate outside of the market and do not have the intimate knowledge of the informal market as do informal lenders. Though, they can collect some market information and set rates accordingly, the centralized and detached nature of the agency prevents it from becoming an interactive part of the informal credit market.

Setting the incorrect interest rate can range from having no effect the informal credit market to having perverse and malignant consequences. An artificially high interest rate has no effect on access to credit by microentrepreneurs because the demand for credit will be satisfied by other microlending firms in the informal credit market. However, when the rate is set too low, the demand for credit exceeds supply -at least at a sustainable level. Due to the size of the World Bank, supply of credit is large, but private interaction in the microlending market is also crowded out. By crowding out the private investment, the World Bank destroys the only self-sustainable form of domestic investment in the informal sector.

Similarly, crowding out will also occur even if the interest rate is set correctly. The World Bank in such a scenario is an active participant in the microlending sector. If somehow the World Bank was able to receive perfect information about the informal credit market, since private firms will enter the market up until they can expect zero economic profit, mere interaction by the Bank crowds out participation by the potential private microlending firm.

The problem of information does not end with the setting of interest rates. Microenterprises are highly dispersed in both economic activity and location. Lending models such as the credit cooperatives have recognized the regionalized and heterogeneneic properties of microenterprise, and thus, have adjusted accordingly. The credit cooperatives rely on a highly regionalized structure to be effective microcredit agents.

Credit cooperatives have demonstrated the most promise of all the formalized microlending agencies. Credit agencies such as the Grameen Bank of Bangladesh have shown both effectiveness in lending to microenterprises and fiscal sustainability. They are successful because they are regionalized to the extent of informal credit agencies, and thus, take advantage of the informal market information available to them.

From 1976 to 1983, the Grameen Bank was a government intermediary to provide credit to the poor of Bangladesh. In 1983 it became an independent bank specifically serving the landless poor (Wahid, 1994). An important component of Grameen Bank's operations is the coupling of savings and credit. All borrowers must deposit weekly savings. The ability to maintain a savings discipline determines borrowers credit eligibility. In addition, the borrower pays 24.5 percent interest and deductions on the loan: 13 percent is interest, 5 percent is deducted for savings in a group fund, and 6.5 is allocated to an emergency savings fund. Selected clients themselves decide who is eligible for credit. Savings is an important instrument in Grameen Bank's ability to loan. In 1986, savings in the Bank amounted to half the outstanding loans (Wahid, 1994).

The Grameen Bank's lending program is also highly regionalized. Approximately 23,000 villages participate in Grameen Bank's lending programs. The selected clients (usually numbering five( form a group that carries out the Grameen Bank's lending in the group's village. Ten of these village groups are then grouped into "center" and an official branch of the Bank oversees several centers. The group structure has both minimized administration costs of the Bank (making it economically viable -and induced an incentives system (through peer pressure (that has brought about a high repayment level of 98 percent.

Though the Grameen Bank practices good economics in its microlending by coupling savings to lending, the most important part of the Grameen Bank's model is its regionalized context. The bank is able to evaluate risk, through its highly regionalized structure, and is able to disperse credit allowing it to find its greatest return. However, the World Bank has no regional interaction. The administration costs of lending to every potential borrower would be enormous. Therefore, the World Bank's lending practices would be highly biased both in region and in the activity of the potential borrower.

Another obstacle in the way of the World Bank engaging in microlending activities is its lack of social context. Informal credit agencies work because they can hedge against default through the use of social pressures. The World Bank is a large centralized foreign agency, and its ability to monitor the cultural nuances that allow for successful microlending is limited. The lenders in the informal market have intimate knowledge of their borrowers. The World Bank has no ability to gain such intimate knowledge, therefore, the only way for the World Bank to hedge against default is to employ the methods of commercial banks -credit ratings, collateral, lengthy application processes.

Coupled with a need to interact with both region and culture is the need to respond quickly to changing credit demands. Again the World Bank's separation from the market hinders its ability to change and respond with the need of borrowers. In the formal sector, the needs of borrowers do not change very rapidly as compared to those of informal borrowers. However, microenterprises have differing credit needs as participants are engaged in very diverse economic activity.

The implementation of a World Bank microlending program that will be able to affect positive macroeconomic change in a developing countries is not feasible. The non-market structure of the organization will not permit it to interact in the informal credit market without perverse and destructive consequences. The sluggish centralized structure that detaches it from market signals prohibits rapid response to the ever changing needs of entrepreneurs.

The cultural and context of the World Bank will prove to always be a hinderence in microenterprise development, perhaps it could serve as intermediary for multilateral support for the informal credit markets that already exist. In this capacity. The World Bank's vast resources could be the fuel for the development of a weak informal credit market. A sophisticated informal credit market could relieve many of the constraints on credit suffered by microentrepreneur.

On the outset, such a plan not only sounds feasible but economically sound. The reality is that neither is true for the same reason as with lending directly to microentrepreneurs; detachment from market operations.

The World Bank is unable to paticipate in or adapt to an informal market context in a beneficial way. However, the Bank would have to operate in sucha an informal context to be effective in a microlending capacity. Therefore the World bank has no way to fend against corruption, set interest rates, allocate credit resources and have any impact indoing so without destroying the very economic context it wishes to enhance. All of these context problems have no solution because of the World Bank's non-market structure.

Fraud is a major concern in lending to informal credit agencies. No enforcible accountability mechanism is present in informal lending agencies to permit such agencies from pocketing the funds allocated for credit disbursement. To remedy this inevitable situation, the World Bank must select those informal lenders that are the least risky, similar to the commercial bank activities. However, the tedious and burdensome process needed to make a selection would be in defiance of the rapid response needed by the informal lenders.

The World Bank has no way by which it can operate in the informal sector and be a benficial member of the informal economic community. Informal lenders are successful because they are able to assess and respond to the information transmitted by informal market mechnisms. Informal lending agents, as active member in their economic and social community, have access to informal credit histories and are able to take advatage of peer pressure to ensure that lenders will not default. Additionaly, the small size of informal lender is conducive to rapid response to a highly dynamic market. Their small size coupled with the nearly perfect information, propagated through social and economic ties to the community, microlenders are highly adapted to their lending environment. This comes as no surprise considering microlending agents operate in the same context in which they were concieved.

The World Bank was concieved in a very different context. It is the quintessential macrolender born in an era of central planning ideals. Therefore, the contextual distance from the informal sector in which the World Bank operates makes it adverse to informal market signals. As a result, any direct interaction the World bank has with the informal sector can only have perverse outcomes. Real interest rates cannot be set by the World Bank. The artificial rates have no effect if to high and cause crowding out if set to low. Also argued before is the existence of crowding out even if the price is correct. Though the individual lender benefits, the informal capital market as a whole suffers, and is thereby consistent with the macro-micro paradox.

The most productive and viable way for the World Bank to abet microenterprise development is to advocate and assist structural change in LDCs. An improved business environment may hurt small enterprise in the short run, but an overall liberalization of historically highly governmentally controlled countries has many macro and micro economic benefits.

Structural adjustment loans (SALs) are the area where the World Bank is most capable of making a difference in the microenterprise world. Seemingly unrelated, SALs are allocated toward financing structural adjustment programs that include economic liberalization in LDCs by the government as preached by McKinnon.

In many LDCs, regulatory requirements make it difficult for potential investors to start and operate their own business, thereby making the economy less accessible and inefficient. Troublesome too are minimum wage requirement and burdensome hiring and firing procedures which make it difficult for businesses to react to changing economic climates. Foreign investment in many LDCs is also either limited or outlawed altogether (Parker, Riopelle, and Steel, 1995).

Privatizing resources and liberalizing imports an interest-rate restrictions improves access to resources by the private sector. Trade restricting tariffs reduce both the quality and the availability of production inputs or finished goods. In addition, the liberalization of the cost of money enhances productivity in the private sector. With interest rates free to float, more firms can have access to credit.

SAPs usually include plans to decontrol prices, devalue domestic currencies and initiate tax incentives for private investment(Parker, Riopelle, and Steel, 1995). Decontrolled prices gives domestic manufactureres more incentive to produce, thus alleviating raw or finished good shortages. In the short run prices will rise, but many producers will enter to take advantage of the relatively unexploited markets.

Though structural changes directly effect only the formal private sector, the indirect ramifications spill over into the informal sector. Increasing the incentives for both domestic and foreign investment makes more financing opportunities available for credit starved operating or starting microenterprises. Deregulations and tax incentives allow the informal sector participate in formal sector activity.

Structural change toward a more liberalized economy allows for more linkages between the formal and informal sectors. Inputs, capital, and investment can flow freely, thus finding their most efficient use.

In conclusion, the World Bank has already found its place in the world of microfinance; structural adjustment programs designed to liberalize the over-regulated and suffocating less-developed economies. Any kind of direct involvement with the informal sector would prove ineffectual, or worse, harmful. The context in which the World Bank exists and was created prevents it from interacting interdependently with the informal market. In the Weberian sense, the context of the World Bank prevent it from engaging in any purely market-driven activity. The World Bank does not have to go out and find its niche in microenterprise development, it has already found it.

Author: David Puglielli - pugliell@stu.beloit.edu
Also see David's Microlending Page
Return to the Documents Section

Hari Srinivas - hsrinivas@gdrc.org
Return to the Virtual Library on Microcredit