Microfinance and street children: is microfinance an appropriate tool to address the street children issue ?

1.2.2. Dynamic incentives

An incentive is defined as something that induces action or motivates effort (the fear of punishment or the expectation of award). As group-lending alone can not guarantee good loan repayments and can create some problems, MFIs have developed innovative mechanisms in order to foster repayment rates.

Those dynamic incentives (Besley, 1995)^59(*) are generally combined with group-lending and are used to overcome information problems and improve efficiency (Morduch, 1999).

The most widely used incentive is «progressive lending». In such a system, a loan of a small amount is first provided and then the size gradually increases as the customer demonstrates good repayment.

This system is claimed to have many advantages. The first is to «test» the borrower's reliability. A second advantage is to increase the borrower's opportunity cost of non repayment as he/she will not have access to a subsequent if he/she does not repay (Aghion and al., 2004).

However, this system contains two risks. First, if there is a high competition among MFIs, the borrower can go to another microlender and ask for a new loan. Second, default attractiveness is proportional to the loan size. The more the size increases, the more the borrower has a higher incentive to default.

Moreover, Morduch (1999) argues that dynamic incentives can be problematic in high mobility areas, because the borrowers can easily leave his/her place and go elsewhere. The efficiency of such mechanisms in urban areas is therefore controversial.

1.2.3. Frequent repayment schemes

One of the other particularities of microfinance is its repayment mechanism. When formal banking system teaches us that the borrower should repay his loan after the investment being made and the profits generated, microcredit lenders often expect the loan to be paid in small instalments, starting soon after the initial disbursement (Aghion and al, 2005). For example, Grameen type loans e.g. have weekly instalments, starting two weeks after the initial disbursement. (Yunus, 1999)^60(*)

Morduch (1999) and Aghion et al. (2005) point out several advantages; it screens out undisciplined borrowers; it represents an early warning system about emerging problems; it is a mean for the bank to select less risky clients (i.e. select borrowers able to repay loans even if investments fail; therefore, the bank relies partly on the «diversified» income of the household, and partly on the cash flow generated by the borrower's investment); and finally it allows the bank to get hold of cash flows before consumed or diverted.

1.2.4. Collateral substitutes61(*)

It has been underlined how group lending is one way to secure the loan, for poor people having generally no collateral to offer^62(*). However, some programs may ask for collateral. Those collateral substitutes may be of two kinds: flexible collaterals and financial collaterals.

Flexible collaterals - as those asked by the Bank Rakyat Indonesia - consist of tangible assets of any kinds (livestock, working tools, etc). However, the main constraint here is the «notional» value of such collaterals, in other words will the fact of loosing the asset be such that the customer will behave prudently? (Aghion and al., 2004).

Financial collaterals, where the borrowers are asked to build up financial assets and then to base lending on those assets. SafeSave, operating in the slums of Dhaka, is a good illustration of that mechanism.

To be able to get the first loan, the borrower must have already saved for three months. The saving requirement is therefore a very powerful instrument, showing the ability of the borrower to manage its money as giving the opportunity to the lender to «capitalize on financial collateral and its special place in the borrower's heart and mind» (Aghion and al, 2005). Indeed, the lender will be able access the savings amount, in case the borrower defaults on a debt obligation.

* ⁵⁹ Quoted in Morduch (1999)

* ⁶⁰ «Banker to the poor, the story of the Grameen Bank» quoted in Calles (2005)

* ⁶¹ We will outline here the two most widely used substitutes. For a comprehensive description of substitutes, see Aghion and al. (2005)

* ⁶² The notion of collateral refers to the assets that the borrower is willing to put up to secure credit ( http://sbinfocanada.about.com/od/financing/g/collateral.htm)