Emmanuel QuaysonThe credit market in Ghana plays an important role in meeting the financing needs of various segments of the economy. A myriad of micro finance companies operate in the country, unlike banks and other regulated non-bank financial institutions, their forms of organisation and methods of working are not standardised. Instead, there is a great diversity in their organizations, methods, functional areas of operation, sources of funds, effective rates of interest charged on their loans and a couple of others.
Their common characteristic is that a quiet number of these micro finance companies are not regulated by any authority. The credit markets in which they operate are unorganized or segmented and not integrated with each other. They are not linked with the organised sector of the credit market either, represented by banks and term-lending institutions.
The rates of interest charged by them differ over a wide range. Reliable and complete information is not readily available about their operations, because there is no official or unofficial central agency to which unregulated financial institutions report their operations. This represents a big gap in our knowledge about Ghana’s finance industry and this hampers credit policy formulation.
The study and knowledge of unregulated credit markets is important because they meet a large part of the working capital needs of several segments of Ghana’s economy. Unregulated credit agencies also play a role which is both competitive with and complementary to that of banks.
They compete with banks by attracting loanable funds from surplus units, a sizeable part of which would have otherwise flown to the banks. In Ghana, some of the rural banks compete with the universal banks in their lending operations and remittance facilities.
However, in most cases, the loan operations of unregulated credit agencies are complementary to those of banks because they provide credit generally for such uses and to such users as cannot be accommodated by banks, therein also lays the rub. The allocation of unregulated credit does not conform to social priorities. In parts at least, it often runs counter to the credit control objectives and measures of the monetary authority.
In generality, credit markets in Ghana have mainly been characterised by the inability to satisfy the existing demand for credit, especially in the rural areas. However, whereas for the informal sector the main reason for this inability is the small size of the resources it controls, for the formal sector it is not an inadequate lending base that is the reason, as stated by Professor Ernest Ayeetey. Rather, the reasons are difficulties in loan administration like screening and monitoring, high transaction costs and the risk of default.
Ghana’s credit markets are characterised by information asymmetry, agency problems and poor contract enforcement mechanisms. They are mainly fragmented because different segments serve clients with distinct characteristics. Because of this, lending units are unable to meet the needs of borrowers interested in certain types of credit.
The result is a credit gap that captures those borrowers who cannot get what they want from the informal market, yet they cannot gain access to the formal sources. Enterprises that want to expand beyond the limits of self-finance but lack access to bank credit demand external finance, which the informal sector is unable to satisfy.
Two main theoretical paradigms have been advanced to explain the existence of this fragmentation; the policy-based explanation and the structural-institutional explanation. According to the policy-based explanation, fragmented credit markets, in which favoured borrowers obtain funds at subsidised interest rates, while others seek funds from expensive informal markets.
They develop due to repressive policies that raise the demand for funds. Unsatisfied demand for investible funds forces credit rationing using non interest rate criteria, while an informal market develops at uncontrolled interest rates. Removing these restrictive policies should therefore enable the formal sector to expand and thereby eliminate the need for informal finance.
According to the structural-institutional explanations, imperfect information on creditworthiness, as well as cost of screening, monitoring and contract enforcement among lenders, results in market failure due to adverse selection and moral hazard, which undermines the operation of financial markets.
As a result, lenders may resort to credit rationing in the face of excess demand, thus establishing equilibrium even in the absence of interest rate ceilings and direct allocations. Market segmentation then results. Market segments that are avoided by the formal institutions due to institutional and structural factors are served by informal agents who use personal relationships, social sanctions and collateral substitutes to ensure repayment.
Another view has attempted to explain the existence of informal finance as simply residual finance, satisfying only the excess demand by those excluded from formal finance. According to this view, informal sector finance develops in response to the formal sector controls.
A further explanation is that fragmentation exists due to inherent operational characteristics of the markets. Looking at the role of informal financial sectors in Ghana, Professor Ayeetey and Dr. Gockel, Ghanaian economists, attempted to investigate factors that motivate the private sector to conduct financial transactions in the informal financial sectors.
They argue that the informal sector derives its dynamism from developments in the formal sector as well as from its own internal characteristics. The informal and formal sectors offer similar products that are not entirely homogeneous, implying that both sectors cater for the needs of easily identifiable groups of individuals and businesses, but at the same time serve sections of the total demand for financial services.
However, participants from either sector may cross to the other depending on factors like institutional barriers, availability of credit facilities and the ease of physical access. These Ghanaian economists examined some of the factors that influence demand for formal savings and lending facilities in Ghana and observed that incomes, bank formalities and banks’ preference for large transactions were the major ones. Travel costs and time are among other factors that determine transaction costs to entrepreneurs.
The major features of rural credit markets that can be used to explain the existence of formal and informal credit markets in Ghana include the existence of collateral security and covariant risk. Collateral security is often beyond the reach of many borrowers in rural areas. Most properties owned by the rural dwellers in Ghana do not have fully registered land title certificates.
This might arise from either a particular landmark not cartographically mapped by Ghana’s survey department or the usual land litigation monster. However, even where this is the case, the ability of the lender to foreclose is often limited, making enforcement of loan repayment difficult.
Such difficulties help to explain the use of informal financial markets, which use social sanctions to ensure enforcement. In rural areas, shocks in incomes that create borrowers potential to default will affect the operation of credit markets. In most rural economies, borrowers are faced with risks arising from uncertainties about their incomes.
By diversifying their loan portfolios, lenders can avert such risks. However, credit markets in rural areas are segmented, with lenders loan portfolios being concentrated on borrowers facing common shocks to their incomes. In incomplete markets, rural households could use partially functioning credit markets to provide insurance against loan defaults by trading insurance. However, due to incomplete information about the nature of the risk faced by each individual, insurance arrangements are only partial or totally absent.
In conclusion, empirical evidence has shown that financial markets in Ghana are characterised by imperfect and costly information, risks and market segmentation, resulting in credit rationing. This is one of the underlying factors in the coexistence of both formal and informal credit markets serving the needs of the different segments of the market.
On the other hand, policy-based and structural-institutional explanations attempt to explain the coexistence of both segments of the market as a result of policy rigidities. Imperfect information emerges as an important explanation for credit rationing. This is because, due to information asymmetry, loan terms and conditions used affect the behaviour of borrowers.
Emmanuel Quayson
Dada Joe
