1185243 What are the typical shortcomings of financial markets in the developing world? What is financial development?

What types of economic problems is financial development likely to solve, and what kinds of problems might it not solve? Explain your arguments.

Financial development is usually defined as a process that marks improvement in quantity, quality, and efficiency of financial intermediary services. This process involves the interaction of many activities and institutions and is possibly associated with economic growth1. Unfortunately in the developing world, coordination and information are scarce amenities. Human capital is not high enough to coordinate, and facilitate savings and other investments in the correct manner to boost economic outcomes. Desperate measures also force individuals to take out loans from unregulated sources with exorbitantly high levels of interest, sending the receiver into a spiral of debt and poverty, thus keeping the population in poverty (if this occurs in the masses). Even the IMF impose very harsh conditions on loans given, inflicting great strife on the poorest, which in some developing countries is the vast majority; this is where projects such as microfinance and microcredit can act as saviours for the bottom of the economic and social hierarchy. When thinking about foreign investment, we must ask ourselves, who would want to invest in a developing country with no real history of A. Financial stability and B. Financial progression? The main trade within developing worlds are those with low levels of human capital; in order for a country to develop economically and financially we typically assume a shift out of these low human capital sectors and into sectors dominated by financial intermediaries and perhaps skilled manufacturing. The problem is however, that there is a lack of education and opportunities in the developing world. by introducing schemes such as microfinance, this can incentivise the population to learn to read and write, allowing individuals to rise to leadership positions in village finance systems. Projects funded through microfinance can also give children schooling opportunities by either funding education or by giving households credit enabling children to stop working and to focus on education. Financial development is able to help the poorest ascend out of the trenches of fiscal despair. It is generally observed that the poor are unable to access bank loans and when able to get loans from either banks or elsewhere, a very high rate of interest is imposed on them. Microfinance has been a hot topic in the past few decades, and has been recognised as a just and sustainable solution in alleviating global poverty. Microfinance is the provision of financial services such as loans, savings, insurance and training to people living in poverty.2 Not only does microfinance give the poor a chance for financial progression, but also breaks down the wall of sexual segregation. Microfinance works for social gain rather than private gain therefore encourages and supports the advancement of females. Research done by UNDP, UNIFEM, and the World Bank, among others, indicates that gender inequalities in developing societies inhibit economic growth and development. A recent World Bank report confirms that poverty is more prevalent, with lower living standards and slower economic growth in societies that discriminate women; clearly gender equality is a key factor towards any development strategy3. In a report on its survey findings the special unit of microfinance of the UNCDF has found that women spend more of their income than their male counterparts, therefore by helping to increase the income of women, we are in fact increasing he welfare of the whole family. Womens success benefits more than one person. Several institutions confirmed the well-documented fact that women are more likely than men to spend their profits on household and family needs. Assisting women therefore generates a multiplier effect that enlarges the impact of the institutions activities.4

1185243 Microfinance could also rectify the problem of gender imbalance within developing countries, a problem which is especially common in India; a consensus showed that there was 100 women for every 108 men5 accentuates evidence of a decades-old Indian preference for male children, who are seen as breadwinners. low income households however now need not predominantly give birth to men for financial stability and wellbeing in the future. As stated before, microfinance can enable households to obtain credit, allowing children to stop work, which they may have previously done in order to help support their household. Microfinance and microcredits ability to achieve more than a traditional loan is also associated to the characteristic of social collateral. By lending to a group rather than an individual, joint responsibility can be a huge determinant in the repayments of the loan. In developing countries where social capital is a large part of culture, individuals may not want to seem perhaps weak by not being able to keep up with repayments. Other recipients of the loan can also pressure members if they fear that they are not keeping up with repayments. Schemes of mentoring and coaching in business can also help enrich the recipients and improve their own self-sufficiency, decreasing their need for help from outside parties, allowing them to use their new acumen and help the community thrive. Lending to small communities allows the lender to screen the recipients character as well as financial history. Typically in small communities the majority of the population is familiar with one another, allowing the lender to get character references from third parties and make a more informed decision as to lend to the individual or not. The idea of social collateral can act as a double edged sword however, with the rich culture of some of these developing nations, men may not wish to make women susceptible to these social implications and may exclude them when taking joint loans. Attaining credit may not be the only problem in developing countries; individuals of the lower middle class may already have some capital, however they do not have the correct knowledge of how to invest it correctly. Even if the right intermediaries were present in the country to offer advice to the individuals, the advice may be situated far away; financial development could also increase the frequency of these intermediaries, thus decreasing distance and search costs and making information both more ubiquitous and cheap, therefore increasing investment and economic growth. Corruption is rife in the developing world; An increase in financial development could lead to an increase in foreign investment in order to try better the situation of the developing world, however with corrupt officials the investments do not always reach their targets. Officials can also deliberately constrict the improvement of human capital and infrastructure in order to keep the population in an underdeveloped intellectual state to exploit workers for their own private gains. Furthermore some cultural groups believe females to be inferior to men; civil unrest could be sparked by outside parties offering credit to women. We must also remember that although financial development may increase the volatility of growth, it may not increase the quality of growth, i.e. factors such as income distribution, which are crucial to sustainability and continuous growth. It is argued that benefitting in the financial sector incurs initial start-up costs; poor households will not find it worthwhile to experience these costs, hence fall even further behind in the distribution of wealth.6 Financial development is a powerful aid in increasing the economic potential of both an economy and its inhabitants. Through schemes such as microfinance and microcredit, individuals now have a chance to increase their welfare as well as their economic and social status. The group that has the most to gain from financial development in my opinion are females. Due to a lack of education, some of the developing world is encapsulated by a medieval frame of mind that women are second

1185243 to men; by making cheap credit available to women and giving them equal opportunities to men, this could be the first chance for females to assert their place in society in the developing world, just as they have done so in the developed one. So who benefits from financial development? Surely the bankers that operate at the heart of the financial system profit but do the poor? Ultimately I think poor are better off with financial development than without it. Even if the financial sector itself does not impact the poor directly, it does generate economic profits in general for the country; with a stable and honest government, economic progression can equal more social safety nets and a more spread out distribution of income.

REFERENCES
1

Financial Development and Economic Growth: Empirical Evidence from Six MENA Countries Suleiman Abu-Bader and Aamer S. Abu-Qarn
2

http://www.opportunity.org/what-is-microfinance/#.UMiVSIPtQ_5

Empowering Women Through Microfinance Susy Cheston and Lisa Kuhn Page 7 http://www.microcreditsummit.org/papers/empowerment.pdf
4

Empowering Women Through Microfinance Susy Cheston and Lisa Kuhn Page 8 http://www.microcreditsummit.org/papers/empowerment.pdf
5

Proximate sources of population sex imbalance in India May 2009, Volume 46, Issue 2 Page 325
6

Financial Development, Growth and Poverty: How close are the links? Patrick Honohan Salford University, Manchester, England September 8, 2003 http://www.microfinancegateway.org/gm/document-1.9.26333/21113_wps3203.pdf