March 29, 2012
Can increasing access enhance or jeopardize the stability of financial systems?By Jonathan Morduch
Regulators hope that expanding financial access will also provide greater stability to the overall financial system. This would occur as the market becomes larger and more diverse, and thus better able to withstand difficulties in any particular corner. The range of depositors would enlarge, as would the kinds of financial institutions in the market. Greater competition among providers would create pressure for quality competition. Regulators hope that expanding financial access will also provide greater stability to the overall financial system. This would occur as the market becomes larger and more diverse, and thus better able to withstand difficulties in any particular corner.
That’s the rosy scenario. The financial crisis of 2007-8 in the United States is a contrasting reminder that expanding access and increasing stability do not necessarily go hand in hand. In the United States, the expansion of mortgage finance opened way for new home buyers to engage in speculative and ill-advised real estate investments, eventually fueling the drama behind the financial crisis (McLean and Nocera 2010). The financial
crisis was created by a range of forces—including fundamental structural inequalities exacerbated by poor oversight, misaligned incentives, and some measure of outright fraud—so generalization should proceed with caution (Rajan 2010). Still, the crisis underscores the larger point: Regulators need a deeper understanding of what can happen to the stability of financial systems when millions of new participants enter. Debates over the benefits and risks of commercialized microfinance as a gateway for financial access have raged since the early days of microfinance.
Neither the 2010/2011 crisis in Andhra Pradesh, nor prior crises in Nicaragua, Bosnia, Nigeria and other locales have resolved those debates.
Clearly there can be a relationship between striving for profitability, fast growth and poor practices leading to overindebtedness of clients and portfolio deterioration.
Yet despite the warning signs, and many public pledges by various industry actors to be working on client protection approaches and social metrics, problems arise regularly. Is there an optimal mix of priorities that protects clients and yet meets the goals for rapid expansion in the number of clients who have access to formal financial services? Is microfinance, like other financial services, likely to experience repeated cycles of boom and bust?
Read other posts from the 10 Research Questions on Improving Financial Access series focused on the questions that need answers if we are to make informed decisions on how to improve financial access:
- Does financial access--evaluated in typical settings with a long enough time horizon to see change--substantially improve the well-being of customers?
- How much does Consumption Smoothing Contribute to the Welfare of Families?
- Why do so many micro-businesses stay micro?
- Is SME finance an alternative strategy to microfinance?
- Which financial services are most valuable to the poorest?
- Are borrowing and savings complements or substitutes?
- When and How does Financial Literacy really matter?
- Can the expansion of microfinance add up to macro impacts?
- What should regulators do?
The series has been compiled as a framing note on the FAI site and will be available later as part of a collection of studies to be published in a forthcoming book.