The determinants of urban hoseholds borrowing in ho chi minh city

empirical studies for demand and supply factors, particularly determinants of access to formal credit by urban households.. FACTORS AFFECTING HOUSEHOLD ACCESS TO FORMAL CREDIT The demand

VIETNAM- THE NETHERLANDS PROJECT FOR M.A ON DEVELOPMENT ECONOMICS

THE DETERMINANTS OF URBAN HOUSEHOLD'S

BORROWING IN HO CHI MINH CITY

By NGUYEN XUAN HIEN

MASTER OF ARTS IN ECONOMICS OF DEVELOPMENT

HO CHI MINH CITY, DECEMBER 2012

First of all, I would like to thank UEH/ISS teachers who have settled my foundations

on development economics and international standard research methodology Through the program, my mind has been opened to the world

I am profoundly thankful my supervisor, Dr Nguyen Trong Hoai for his ideas and comments on my research questions, literature review and reference His intellectual supports make very complicated economic development theories become simple ones in my mind During the course, I have received numerously his kind supervision, guidance, useful comments and encouragements

I am especially grateful to Dr Nguyen Huu Dung who gracious made available advices and suggestions for me to improve the content and English writing of my thesis

I also thank all my classmates and my colleagues for their helps, encouragements and cooperation during my learning and doing research time

Last but not least, without encouragement, tolerances and loves of my parents, my younger sister, my relatives, my friends and my wife, this research would not have been completed So, I would express my deepest debt to them

Table 3.6- Sectors that loan spent Table 4.1 - Table of independent variables Table 4.2 - The result of regression model

CONTENT OF THESIS

CERTIFICATION 2

ACKNOWLEDGEMENT 3

1 LIST OF TABLES 4

CONTENT OF THESIS 5

CHAPTER 1: INTRODUCTION 7

1.1 Problem statement 7

1.2 Research Objectives 9

1.3 Research questions 9

1.4 Research methodology 1 0 1.5 The structure of the thesis 10

CHAPTER 2: LITERATURE REVIEW FOR URBAN HOUSEHOLD'S ACCESS TO I FORMAL CREDIT 12

2.1 DEFINITIONS 12

2.2 FACTORS AFFECTING HOUSEHOLD ACCESS TO FORMAL CREDIT 13

• 2.2.1 Traditional approach 14

• 2.2.2 Financial repression approach 15

2.2.3 New institutional economics approach 15

2.3 THE CREDIT MARKET MODEL 17

2.3.1 Credit demand and household financial behavior 18

2.3.2 Credit supply and behavior of formal financial intermediaries 19

2.4 EMPIRICAL STUDIES 25

2.5 CHAPTER REMARK 32

CHAPTER 3: FINANCIAL SYSTEM AND ACCESS TO FORMAL CREDIT BY • HOUSEHOLD URBAN IN HO CHI MINH CITY 34

3.1 FINANCIAL SYSTEM IN VIETNAM 34

3.2 OVERVIEW OF ACCESS TO BANK CREDIT BY HOUSEHOLD URBAN IN HO CHI MINH CITY 37

3.2.1 Formal and informal credit sources are co-existing 37

3.2.2 Comparing the interest rate between formal and informal credit sources 39

3.2.3 Ability to access bank credit by household, production and financial characteristics40 3.2.4 Characteristics of loan uses by urban households in Ho Chi Minh City 43

3.3 CHAPTER REMARK 46

CHAPTER 4: RESEARCH METHODOLOGY, MODEL SPECIFICATION, RESULTS AND INTERPRETATION 48

4.1 RESEARCH METHODOLOGY 48

4.2 DETERMINANTS OF ACCESS TO FORMAL CREDIT BY HOUSEHOLD 49

4.2.1 Model specification 49

4.2.2 Data extraction 51

4.2.3 Interpretation of regression results 52

4.3 CHAPTER REMARK 51

CHAPTER 5: CONCLUSION AND POLICY IMPLICATION 60

5.1 Conclusion 60

5.2 Policy implication 63

5.3 Research limitations 65

REFERENCES 66

APPENDICES 72

CHAPTER 1: INTRODUCTION

1.1 PROBLEM STATEMENT

Finance now plays an important role in economic growth and development The financial services are the services provided by the financial institutions, intermediation or organizations that dealt with the arrangement and management of money, it also can be described as a set of arrangement including lending and borrowing of funds The improvement of household's borrowing and accessibility to credit can increase the opportunity for income generation and improve the living standard and thus reduce the poverty, inequality and vulnerability, especially for the low income and poor households So, access to credit plays a major role in increasing household's conditions, particularly for the low income and the poor When credit is accessible, the household can solve the problem of lacking of finance that would negatively affected household's conditions Providing credit services and removing the constraints can be positive means of improving household's living standard

So, the government always tries to improve household's borrowing and access to financial services (especially access to the formal credit sectors) because of the interest of household received from financial services Many financial institutions, intermediation or organizations and credit programs with preferential interest rate and lending policies are established to fulfill the accessibility of household to formal credit Like others developing countries, the government of Vietnam has created some credit institutions These institutions have function to provide credit, loans with the low interest rate and enhance provision of financial services for the household In developing countries, households have a high demand for credit Credit demand can be used for production, investment, consumption purpose (Donald, 1976) To satisfy the demand for credit, household can find borrowing in the credit market

In Vietnam, the credit market characterized by the co-existence of formal and informal credit sectors The formal credit sectors preferred to this paper are social policy bank, state-owned commercial banks, representative offices and branches of foreign banks, foreign joint-venture banks, domestic joint-stock commercial banks, people's credit funds and cooperatives,

employment support fund, credit organizations, social political organizations while the informal credit sectors are individual creditors, friends and relatives and others The formal credit system provides credit for the household, especially for the low income and poor households, with the favor interest rate While the informal one charge higher interest rate compare to formal credit However, household's access to formal credit is still limited, especially for formal financial institutions There are many factors that affect this problem such as asymmetric information, transaction cost, the household head characteristics, the production characteristics, the financial characteristics, etc All of these factors can determine

of access to formal credit of the household

Up to now, there are several similar studies which have been done to prove the positive impact of access to credit on household's activities and try to find out the determinants of household's access to formal credit such as Rural development finance in Vietnam: A micro econometric analysis of household surveys (Pham Bao Duong and Y oichi Izumida, 2002); Effects of the value of assets on farming household's access to credit in rural Viet Nam (Nguyen Van Ngan, 2003); Effecting of loan amount on farm households income in Tan Chau district, Tay Ninh province (Dang Ngoc Quy, 2007)

Although there are several studies that carried out to find out the determinants of household's access to formal credit in the urban and rural areas, the studies have been done for household's access to formal credit in Ho Chi Minh City are still limited Because Ho Chi Minh City now is the economic heart of Vietnam and the core of Vietnam's largest urban area, which is head toward a population of 9 million, including exurban areas beyond the municipal boundaries The urban development trends in the Ho Chi Minh City area are similar to those

of high income world urban areas That's a reason why Ho Chi Minh City now attract huge immigration of labor force (including manual workers or blue-collar workers, skilled and unskilled worker) from other provinces of Vietnam They move to Ho Chi Minh City for their better life and future Understanding household's access to formal credit in Ho Chi Minh City

is very essential to increase the probability of households to access to formal credit sectors and

to improve the household's income and living standard

Therefore, finding answers for the question that what are the determinants that affect household's access to credit and why a large number of households do not get access to credit, particularly to formal credit, is very essential The findings will help us to understand the credit market and borrowing by households in Ho Chi Minh City This research not only takes

a study of urban credit market with concentrating on borrowing by urban households in Ho Chi Minh City but also is important for the government policy implications to increase the access of household to formal credit

1.3 RESEARCH QUESTIONS

The main objective of this thesis is to try to find out the answer for the central research question: What are determinants of urban household's borrowing or access to formal credit in HCM city?

To answer the central question above, three small detailed questions need to be addressed:

+ What are the differences between formal and informal credit sectors?

+ What are the characteristics of formal and informal borrowing by urban household? +What are the relationship among characteristics and endowment of urban households and characteristics of loan, loan amount and source of loan?

The dataset has been drawn from VHLSS 2008 and processed by using Stata 11.0 software After getting the necessary information, statistical descriptive, comparative method, and econometric technique will be used to analyze the information The statistical description and the comparative method will allow us to have a general picture of the urban credit market and household characteristics in the relation to access to formal credit They also provide us some beginning hypothesis tests of the relationship between each independent variable and the dependent variables The two econometric methods used are logistic and OLS regression to estimate the effects of the household's characteristics on the probability to access and the extent of access to formal credit And the research questions can be answered

1.5 THE STRUCTURE OF THE THESIS

This thesis includes five chapters With exclusion of chapter 1 (chapter of introduction), four continuous chapters present the investigations and findings

Chapter 1 introduces background, problem statement, research objective/questions,

research methodology and structure ofthesis

empirical studies for demand and supply factors, particularly determinants of access to formal credit by urban households

Chapter 3 provides an overview of financial credit market and borrowing by urban

households in HCM city An overview of credit suppliers for urban households and the financial system are mentioned The statistical descriptive techniques are used to present the whole picture of urban households in HCM city From the statistical analysis, the effects of household's characteristics on access to formal credit and loan amount are discussed

Chapter 4 includes hypothesis, data sources and methodology and it is used for testing

hypothesis and interpreting the regression result It presents two main types of econometric model (Logit and OLS) that qualify the determinants of probability and the extent to formal credit by urban households in HCM city The models used in chapter 4 are specified from the theoretical review and empirical studies in chapter 2 and the context of credit market of HCM city in chapter 3 Model and data to run econometric regression, interpretation of the econometric results are also included in this chapter

Chapter 5 presents a summary of main findings and discusses some policy

implications From these findings, some policy implications and suggestions for further studies are developed

I

-CHAPTER 2: LITERATURE REVIEW FOR URBAN HOUSEHOLDS'

ACCESS TO FORMAL CREDIT

The literature includes two main parts The first part includes the concepts, the different approaches of the determinants of access to formal credit, credit model The second part is empirical studies about the determinants or factors of household's access to formal credit

2.1 DEFINITIONS

Household: is a group of at least two people contributing their incomes for using

(Ringen, 1991) According to McCarty (2001), households live in the rural area are more likely to borrow from formal credit sector than households live in the urban area

Access to credit: this concept must be clarified When analyzing access to credit, we

consider both demand and supply sides (Diagne, 1999) Considering access to formal credit as

a decision making process where the first is the borrower application and the second is the lender approval (Tran Tho Dat, 1998)

Access to formal credit could be expressed by two ways The first way is probability

or accessibility that household can access formal credit (Tran Tho Oat, 1998) To measure the determinants of household's access to formal credit, the dependent variable- access to formal credit - is usually in form of dummy variable, access or not access to formal credit The econometric method used to estimate this model is usually the logistic or probit method The last one, access to formal credit could be measured by loan amount (Diagne, 1999) and then,

to estimate determinants of access to formal credit, we also can use OLS method

The borrowing process includes four continuous stages (Tran Tho Dat, 1998) Firstly,

household makes a decision to apply for credit or not Secondly, if the household has demand for credit, they decide to take part in the process, and then they choose the loan amount Thirdly, the lender starts to assess the loan application of borrowers, then makes a decision to provide loan or not Finally, based on the borrower's creditworthiness and the conditions of lender, the lender determines the loan mount that household received

The research of Moll (1998) told that households decide to apply for formal credit not based on their capital demand and their perceived information about credit supplier, which depend on the household head, production and financial characteristics Then, based on the information about the financial, production status and other personal information of applicant, lender will judge the creditworthiness of the applicant and make decision to partially or fully accept the loan applications (Adam, 1980) That means lender's decision to approve the credit applicant depends on both credit demand and supply sides In short, both demand and supply factors will affect access to credit

Formal versus Informal Financial Institution

The formal financial institution is an institution that operates under a government

1 regulatory framework (Moll et al., 2000) If we consider the development point of view, formal institutions are classified by their development functions, such as Commercial Banks, Joint-stock Banks, some special Programs or Institutions, Development Banks, Cooperatives and other non-financial institutions including insurance companies, finance corporations (Padmannabhan, 1988; Moll, 2000)

The fifteenth international conference of labor statisticians of United Nation economic and social council (1993) defined the informal sector as "All unregistered and unincorporated enterprises below a certain size including micro enterprises owned by informal employer who hire one or more employees on a continuing basic, and own account operations owned by individual who may employ contributing family workers and employees on an occasional basic" Generally, informal credit sector includes commercial and non-commercial lenders The commercial segment includes professional moneylenders, input or output traders, and landlord who usually charge higher interest than the formal lenders The non-commercial lenders comprise friends, relatives, some self-help groups, and rotating savings and credit associations (Padmannabhan, 1988)

2.2 FACTORS AFFECTING HOUSEHOLD ACCESS TO FORMAL CREDIT

The demand and supply sides are jointly considered when analyzing access to formal credit, so any factors that affect behavior of credit demander and supplier will determine the access to formal credit Credit can be considered as one kind of commodities, therefore

"

interest rate (or price of credit) will determine both demand and supply side (Donald, 1976) A higher interest rate will make demand decreases and supply increases Interest rate is a main determinant of household's access to formal credit However, in reality, the formal credit market is very different from the goods market The role of interest rate as price mechanism does not function well A credit market is characterized by limited supply but excess demand Formal interest rate is always lower than the market level (Ray, 1998) So, using other factors rather than interest rate can be concerned to explain the determinants of access to formal credit

Now, we consider different approaches and theories affecting to borrowing activities, then influence on household demand for credit and creditworthiness in credit supplier decision which determine household's access to formal credit (Moll, 2000)

2.2.1 The traditional approach to credit market

The traditional approach said that interest rate mechanism function well in rural credit market Low interest rate will stimulate farms to borrow, increase the adoption of new technology then lead to high productivity and high income High interest rate will prevent farms from borrowing Based on this, this approach supports the intervention of government in rural credit markets by keeping low interest rate, increasing saving, creating credit and having subsidized credit for households (Wai, 1957, Bottomley, 1964)

In order to strengthen the argument for government intervention in rural credit markets, this approach assumes that credit is an important input or production factor as capital shortage is a main obstacle for economic growth in rural area (Floro et al., 1991 ) From this assumption, we can infer that credit requirements will depend on production characteristics of households because credit as one part of capital factor must combine with other production factors in production process (Adam, 1984) However, this assumption is not always true because credit can be used for consumption purposes Households, especially the poor, usually use credit to smooth their consumptions and to cover emergency cases such as illness, death, crop failure, falling price and hence, the consumption expenditure may also affect credit demand, then access to formal credit of households (Ray, 1998: 529-31 ) Credit can be used

1991 ) That means interest rate is not important determinant factor of household access to low interest rate credit

The next two approaches will be explored other factors rather than interest rate will affect the household access to formal credit

2.2.2 The financial repression approach to credit market

The financial repression approach argued that credit market is imperfect, low interest rate in formal sector directed the limited credit toward some large borrowers or people who has social and political position (Floro, et al 1991 ) The lenders are likely to concentrate on large loans rather than a number of small borrowers because their administrative cost could be minimized (Donald, 1976) People who have the political and social position will affect the creditworthiness as perceived by lenders, so they have more chance to access to credit Those belong to better-off group and the formal credit sector discriminated against the poor and created environment for corruption (Adams and Von Pishchke, 1984 )

In conclusion, the argument of financial repression approach is that transaction cost, the political and social position; loan size could determine household's access to formal credit The allocation of credit may result from rational behavior of lenders and borrowers and government intervention

2.2.3 The new institutional economics approach to credit market

This approach also supports the credit market is imperfect similarly to the financial repression approach The difference is that, allocation of credit through non-interest rate mechanism is from rational behavior of lenders and borrowers in asymmetric information environment of credit market, not resulted from government regulations (Floro et al., 1991 )

Asymmetric information means information between lenders and borrowers is not balance, which closely connect with "adverse selection" and "moral hazard" problems (Besley, 1994)

Generally, interest rates in formal credit markets are lower than the market equilibrium level as mentioned above (Donald, 1976 and Adams, 1984) Credit demand excesses credit supply; formal suppliers expect to get higher return by increasing the interest rate However, because of symmetric information problem, high interest rate will lead to "adverse selection" and "moral hazard"

Adverse selection means higher interest rate will attract more risk projects, household with low profitability and safe projects could hesitate to borrow because their profit might not cover the high cost So, the risk of loan is high

Moral hazard occurs when borrowers from high interest rate credits are pushed toward risky projects with high expected return Those projects are more likely to fail and these household go bankrupt, so the probability of making repayment is low In brief, rising interest rate in credit market would drive away the good borrowers instead of the bad one (Ray, 1998: 555) As a result, because the risk of investment projects is high and the chance to make repayment is low, the lenders can not attain high return as expectation

Because of adverse selection and moral hazard, lenders can allocate credit by interest rate mechanism Before accepting the loan application, they usually examine borrowers' risk based on some household characteristics that can be observed including main occupations of household head, education and reputation of household, land area, housing conditions (Ray, 1998) The observable characteristics will affect access to credit of household, so formal credit sector like to lend to people whom they have enough information

non-to know the reliability non-to be sure that borrowers will use the loan wisely, efficiently and make repayment in time The absence of information may explain why lenders choose to not serve some borrowers (Moll et al., 2000)

These characteristics can be observed easily and the lenders want to lend to people that have enough information to ensure the loan can be used wisely and repaid in time That affects household's access to formal credit sectors in lender's assessment So, this approach supports

observable characteristics such as land, household condition, household assets, occupation and education of household head can affect household's access to formal credit

In conclusion, the general conclusion of different approaches is that each approach emphasized the role of factors to household's access to formal credit, the after approach (the traditional approach, the financial repression approach and the new institutional economics approach to the credit ordered by time) always tries to complete the before one by criticizing the shortcomings and complementing the new ones For example, the traditional approach suggested that interest rate and production factors are important determinants of household's access to formal credit However, the two next approaches argued that formal credit can be allocated by non-interest rate mechanism, so the interest rate is not important factor These approaches found out formal credit can be used for production and consumption purposes; therefore household's access to formal credit might be affected by household's consumption and household's production Furthermore, the repression approach added loan size, social and political position and transaction cost that are important determinants of household's access to formal credit The latest one, the new institutional approach explored the imperfect information in credit market and there are relationship between household's access to formal credit with main occupations of household head, education and reputation of household, land area, housing conditions

2.3 THE CREDIT MARKET MODEL

As mentioned above, the price or the interest rate mechanism does not work well That means interest rate is not important determinant factor of household's access to formal credit sectors So, the allocation of credit that not based on interest rate (or non-interest rate allocation of credit) may come from rational behavior of lenders and borrowers and government intervention That's a reason why non-interest rate allocation of formal credit is not only result from government intervention but also result of borrowers and lenders' behavior To explain how household can access to formal credit, we can use credit market model Access to formal credit means households has at least a loan from formal credit sector The credit model includes an analysis of credit demand and household financial behavior and credit supply and credit supply's behavior

2.3.1 Credit demand and household financial behavior

Credit borrowing is a decision making process The application process depends on household has demand for credit or not Some households do not apply because they have no demand for credit Others may have demand for credit but do not apply because they scared of debt, have no information, or the procedures are complex These households are classified as credit constrained (Zeller, 1994) In this paper, we consider households who have demand for credit

Credit demand comes from gap between financial inflow of household income (Y) and resource (R) and financial outflows of expenditure (E) The function of credit demand can be:

B = f(Y-, R-, E+) [2.1]

Demand for loan (B) rises when expenditures increase or incomes fall or household resources are low, and ceteris paribus Income mainly comes from production, investment activities of household and wages/salaries that households can earn from working outside Resources may be in form of production assets, real estates and other household assets (David and Meyer, 1979)

The expenditure outflows may be in form of funds for investment or consumption expenditure Investment demand is usually in form of expanding production by applying new technologies, buying or renting new machineries and additional land Another kind of demand for credit is credit used for consumption Credit demand for consumption in emergency case such as ill, funeral, other ceremonies,

Income, production assets, real estates and other household assets, investment, consumption expenditure and production characteristics could affect credit demand and then, affect household's decision to apply for formal credit or not However, having credit demand does not fully explain decision to apply for formal credit; some other factors will be analyzed

to determine household access to formal credit as follow:

(Donald, 1976) has argued that political and social position of households will affect household's formal credit application because they have closed relationship with bank staffs, knowledge and information about credit program so they easily apply for formal credit

(Kooreman, 1997) mentioned in the theory of household economics, demand for credit

of households is always restricted by the limitations including knowledge, skills, wealth and time Education of household will affect their access to formal credit because to get formal credit, households must deal with various paper documents that require a certain education level Moreover, high-educated households seem to have better investment plans and easily apply for formal credit Household wealth reflects their financial capacity and richer household will have less demand for credit Furthermore, young households have more children, so they tend to consume more earnings so they might borrow to maintain their consumption while old households will borrow less

In conclusion, the combination of theories about the credit demand, credit behavior of households and the household economics suggested that age of household head; education of household head; members in a household; the poor (household is poor or not); working for wage/salary; working in sector of agriculture and business or trading; consumption capacity; housing condition (house value and house owning); will have effects on household's access

to formal credit We will analyze these determinants later after considering the factors of credit supply and behavior of formal financial intermediaries

2.3.2 Credit supply and behavior of formal financial intermediaries

In the capital market of developing countries, the supply of credit is always smaller than the demand for credit, so suppliers or lenders have to assign the limited credit among credit applicants or borrowers The credit intermediaries are more likely to lend people who they have enough information and know the reliability to ensure that they will use loans wisely, efficiently and make repayment in time The absence of this information may explain why lenders choose not to serve these borrowers (Moll et al., 2000)

To support the important role of information of borrowers in lender's decision whether

to lend or not Hoff and Stiglitz (1993) have drawn out lending activities as follow At the first step, the lenders must have some money sources which come from their own assets, deposits and savings of citizen, or their borrowing from outside such as from other banks or from lending foreign The second step, the lenders must find a way to ensure repayment and against defaults by assessing applicants' creditworthiness To assess that, the lenders must study many

aspects of the loan applicants (Rose, 1996) The household must well-defined the purposes of using loans and serious attentions to make repayment The household head must have responsibility and truthfulness Besides, income generating capacity of households is also important considerable information, this capacity directly or indirectly depends on education, health, age, occupation and skill Third, the borrowers must have ability to generate enough cash

Furthermore, according to the analysis of formal credit sectors, low interest rate has real effects on formal lenders' credit allocation Formal lenders will allocate the limited available loans toward household with social and political position These households usually have closer relationship with banking staffs, so they are easier to access to formal credit (Moll

et al., 2000) Low interest rate will make lenders overemphasize on collaterals to deal with risky problem So, with some large borrowers, if they have enough assets for collateral, they will easily accepted by financial agencies (Donald, 1976)

Low interest rate in formal credit sector reduces the role of interest rate in determining credit demand and credit supply and raise the important role of collaterals, assets of borrowers, land areas, age, education, occupation, skill, health, political and social position and incomes

of households, have effects on lenders' perception about households' creditworthiness

In summary, the combination of theories about credit supply, credit behavior of credit suppliers suggested that the main determinants of access to formal credit in credit supply side include age ofhousehold head; education of household head; gender or sex ofhousehold head; members in a household; working for wage/salary; household's activities for production or service planting breeding, forestry or aquaculture (do agricultural sector) and households do trading or business; housing condition (house value and house owning) and purpose of loan;

So, some variables affect both on credit demand and credit supply side, such as age of household head; education of household head; members in a household; working for wage/salary; household's activities for production or service planting breeding, forestry or aquaculture (do agricultural sector) and households do trading or business; housing condition (house value and house owning) Some variables affect on credit demand side such as the poor

(household is poor or not), consumption capacity Some variables affects on credit supply side such as gender or sex of household head, purpose of loan

That's a reason why we can draw out factors one by one that determine credit demand and credit supply, and then have impact on the household's access to formal credit

Factors determine both on credit demand and credit supply:

The vector of household head characteristics:

Age of household head

According to the analysis of factors affecting households' income generating activities

of Rose (1996), the access to formal credit and the age of household head have ambiguous relationship On one side, young households have more demand for credit More demand for credit because they consume more than save and they are so young, so dynamic, so active and willing to take risk for higher return So, young households like to apply for formal credit and have more opportunity to access to formal credit sectors Old household head may have less demand for credit than the young ones because they tend to slowly realize and risk-averse Moreover, in Vietnam, older households hesitate to apply for more demand for credit because they have experience about bad reputations of Vietnam's banking system, as imprudent regulations and complex bureaucracy procedures (Jansen, 2000) On the other side, old households may control more sources, have more experience, responsibility, good reputation, and truthfully then more likely to apply formal credit and more accepted by formal lenders (Rose, 1996; Tran Tho Dat, 1998) Age of household head is measured by the years since he/she was born to the surveyed year Age of household head and access to formal credit are ambiguous

Education of household head

The degree that household head obtained (or we can say Education of household head) is also one of important factors affects on access to formal credit The degree that household head obtained has been expected to positively affect on household's access to formal credit Actually, higher educated household head is expected to exploit better production and investment opportunities, to understand and easily deal with banking sector

with complex document procedures and banking staff, so get higher probability to apply and get formal loans (Tran Tho Dat, 1998)

Members in a household

The relationship between the members in a household and access to formal credit seem to be ambiguous The family has consumption more than saving, more demand for credit, so they tend to apply for loans to satisfy their needs while some banks aim to provide loans for investment, production, not for consumption purpose, so they hesitate to loan households with high consumption expense compare to low income, so low probability to be accepted by banks (Rose, 1996; Moll et al., 2000) and the numbers of household dependents seem to have negative effect as it reduces the household creditworthy in lender's assessment (Tran Tho Oat, 1998) On the other side, with households have more people who work for wage/salary or run self-business, they easily generate income and use it for repayment, so the probability and the loan can be accepted by formal lenders will be higher (David and Meyer, 1979)

The vector of production characteristics of household

Working for wage/salary

The relationship between working for wage/salary and access to formal credit is expected positive When providing loans for household, the banks always take into account the generating income activities of household If the household head works for wage/salary, the formal lender can use the household head's wage/salary to ensure the loan repaid So, the probability and the loan can be accepted by formal lenders will be higher

Working in sector of agriculture and business or trading

Household's activities for production or service planting breeding, forestry or aquaculture (households do agricultural sector) and households do trading or business is expected to be positive relationship with access to formal credit Firstly, self-employed household in agricultural sector (with breeding, forestry or aquaculture activities) and doing trading or business can get higher probability to be accepted by banks, especially for banks with support the production activities Secondly, these kinds of household can get profit from their own business to ensure bank's loans repaid and it is easier accepted by banks

The vector of financial characteristics of household

Housing condition (house value and house owning)

Another important factor to consider household financial capacity is housing condition The effect of housing condition (house value and house owning) and extent to have formal credit of household are is ambiguous On one side, the effect is expected to be positive because house can be used for collateral, so more valuable housing is more likely get formal credit If the house have more valuable can raise the ability to repay and increase the creditworthy in the assessment of lenders (Ray, 1998) On the other side, housing condition could have negative effect on household's access to formal credit because good housing condition could reflect stronger financial capacity of household, so their demand for credit would decrease (David and Meyer, 1997; Kooreman et al., 1997)

Factors determine only on credit demand side:

The vector of household head characteristics:

The poor (Household is poor or not in 2007)

The relationship between household is poor or not in 2007 and access to formal credit

is ambiguous expected (Khalid, 2003) If the household is poor, the bank hesitate to loan households with low income, low ability to repay in future, so low probability to be accepted

by banks However, if social policy bank, employment support fund, credit organizations, social political organizations, some special government microfinance programs provide credit

to the poor households including Job creation Program, Hunger Eradication and Poverty Reduction Program and other microfinance programs, the poor household will access these sources of credit, so higher probability to be accessed the formal credit sector

The vector of financial characteristics

Consumption capacity

Two factors of income and expenditure of household should not include in the same model because they are highly correlated Income should be excluded because they it is very complicated factor and difficult to collect accurate data Consumption capacity is expected to ambiguous associate with household's access to formal credit On one side, more consumption

Factors determine only on credit supply side:

The vector of household head characteristics:

Gender of household head Gender of household head may have effect on household's access to formal credit if there is discrimination between male and female in access to formal credit Women considered

as inferior class in traditional society But in the modem society, Vietnamese, especially for the young generation, has been strongly affected by Western cultures (Pham Xuan Nam &

Peter Boothroyd, 2000) Moreover, man and woman are indifferent in legal system of banking sector in Vietnam The woman is encouraged from participating on formal loan and some special program of government So, the relationship between sex and access to formal credit is not clear

The vector of financial characteristics Purpose of loan

The purpose of loan (or the loans used for) seems to have positive relationship with access to formal credit Because some formal lenders target at providing loans to support production and investment activities, while some formal lenders are willing to provide credit for consumption and others, so higher probability to access to formal credit

After examining determinants of household's access to formal credit, we can summarize factors that affect on accessing to credit by household as mentioned above

access to

demand Purpose of loan

2.4 EMPIRICAL STUDIES

There have been a lot of studies on factors affected the household's probability to get different credit sources and the loan amount Here are some examples:

Floro and Yotopolous (1991)

Floro and Y otopolous ( 1991) studied "Informal credit and new institutional economics: the case of Philippine agriculture" In this study, the model is presented as followed:

Loan size= F (income, default incidence, regional dummies) [2.2]

In the regression result, the loan size provided by trader-lender is positive and strong relationship with income On the contrary, the size of loan provided by farmer-lender shows a weak and negative relationship The loan size is likely to have positive effective default

Based on this study, we can consider and select variables the same meaning to add into the research model such as size of loan, household income (with the proxy is expenditure),

Zeller (1994)

Zeller (1994) studied "Determinants of credit rationing: a study of informal lenders and formal credit group in Madagascar" The model by Zeller (1994) briefly presented as follow:

•

PROB (APPLY) = F (1, H, E) PROB (SUPPMAX) = F (1, W, E, L) Where: APPLY (0 =not apply, 1 =apply)

H: vector of household's endowment m human capital that affect credit demand (education, dependency ratio)

E: vector of household events that expected to positively affect credit demand (bad harvest, positive but costly social events such as marriages and circumcisions, migration or death of family member)

W: vector of household characteristics affecting lender's decision (value of assets like livestock and monetary saving that can be easily liquidate in order to repay a loan, value of house assets not owned by individual at beginning of recall period)

L: vector of repayment ability (ratio of outstanding debt over last year's income as a proxy for income earning capacity, outstanding debt of household)

Based on this study, we can consider and select some variables to add into the research model such as age, sex and education of household head, being a wage labor, value of house, value of assets,

Pham Bao Duong and Y oioh Izumida (2002)

Pham Bao Duong and Y oioh Izumida (2002) studied "Rural development finance in VietNam: A microeconomic analysis of household survey" In this empirical, they survey 300 households in three provinces, including Ninh Binh (in the North), Quang Ngai (in the Center) and An Giang (in the South) From the survey result, in the Viet Nam rural credit market, the participation of household is segmented Household can borrow from both formal and informal credit sectors While the formal sectors provide lending for production purposes, the informal sector uses lending for consumption Because of low interest rate, household first

I

tries to access to formal financial institutions When there are many applicants, this cause credit rationing by the banks

And the model can be presented:

(i) The Tobit regression model is used to estimate the borrowing functions specified:

yi = yi* = a+ p.[X] + ui ifyi* > 0 With ui =IN (1, oi)

Where:

- i is the source of loan (formal or informal)

- yi is the dependent variable: amount of credit market

- [X] is the vector of independent variable: number of dependants or number of adults, schooling of household, total production value of livestock, age of household head, dummy variable for each province, farm size and farm size squared

The borrowing function is defined as:

Formal/Informal borrowing decision= f(Loan purpose, Production capacity, Age and

Education, Regional dummy) [2.6]

- Loan purpose: consumption or production

- The proxy of household capacity of livestock production is the total production value

of livestock of the household

-Age and education of the household head

(ii) The Probit model used to estimate the determinants of credit rationing by the formal lenders

Ration = 0: applicant was not rationed in loan demand

Ration = 1: was rationed

Probit (ration) = F (total value of capital, total assets value, total value of livestock which easily can be sold in exchange for cash, number of dependent, age, education, farm area that household owned, reputation, social status, amount of loan applied, interest rate, dummy for regions)

•

Binswangger and Sillers (1983) indicated that household wealth can explain their access to formal credits The main asset of farm is land own area, so farm size has important role in determining their access to low interest rate credit from formal credit sectors (Moll et al., 2000: 35)

Eswaran and Kotwal (1989) analyzed households by using their characteristics including household head, production and financial characteristics Then demonstrate that all these characteristics, especially farm area had significant effect on their access to formal credit

The regression result of Wet (1991) was that age and education level of household head, cultivated land area, saving deposit, loan purposes and household's location have significant effect on determining households' access to the formal and informal credit in China (Tran, T.D., 1998: 36)

Sexton (1997) suggested some characteristics ofthe borrower affected on the lender's decision such as home owner, home renter, single, married, separated or divorced, age, number of dependents, primary monthly income, home telephone, presence of extra income, credited investigation made, good credit record

Diagne (1999) analyzed the determinants of household access to formal and informal credit in Malawi In his research, household access to formal credit estimated by the probability that it can get from formal credit or not, or by amount of loan that they received from the lenders The access to formal credit can be measured as the loan amount; The household head is a member of the local micro credit program or not, has significant contribution to the access to formal credit Land holding size has positive effect on the access

to formal credit Moreover, this study also explores effects of other demographic variables on household access to formal credit

Moll (2000) and his associations studied the determinants of households' access to different credits including formal financial intermediaries, commercial and non-commercial informal credit suppliers They concluded that households' characteristics express both demand for credit and creditworthiness in lenders' perception Particularly two main factors,

Y =a+ ~X+ yZ + olMl + + MM4 + cplLl + + cp7L7 [2.7]

Where: X = family size

Z =In (family income)

Ml M4 = dummy variables indicating martial status

Ll L7 =dummy variables indicating location

Y = logit for type (loan/grant), amount of loan or amount of grant

Furthermore, some empirical studies in Vietnam also show that household characteristics have determining roles in the probability to get formal credit

The conclusion of the paper of (Tran Tho Dat, 1998) was that among household endowments, farm size has positive effect and farm size squared has negative effect on household probability to access to formal credit That means as farm size increases, it becomes less important determinant in their applying to formal credit and indicates their choice of using credit for other activities rather than cropping which depends less on farm size Besides farm size, number of dependents has statistical significant negative effect

Studies of Do Quy Toan et al (2001) also agreed that the process of slowly granting land red certifications for the household is one of the considerable obstacles that prevent the households from accessing to the formal credit sectors

Here are some summaries of empirical studies and the coefficient sign of determinants

of access to formal credit:

Table 2.1: summarize empirical studies and coefficient sign of determinants of accessing to formal credit:

•

•

•

Author, year, country Significant determinants of

access to formal credit, coefficient sign

Methodology

Moll et al., 2000, El Demographic characteristics: age, Combine different insights

household head ( + ) financial markets into a Production characteristics: land dimensional analysis, with

Financial characteristics: income of lenders and the demand for

and then run regression function

local micro credit program ( + ), Regression to measure access

probability and extent of access to credit

Do Quy Toan, et al., slowly granting land red Regression to find out

probability of household's access to formal credit

sectors Other studies Education level ( + ), average Regression to find out the

income (+), land area (+), number effect on determining

of family labor (+), consumption households' access to the

expenditure (-), age ( +) formal (or even the informal)

Different studies used different econometric methods to estimate the effects of households' characteristics of access different credit sources These methods can be generally divided into two methods, combination or separation the effect of demand and supply factors

By using the logistic model or OLS method, my thesis will jointly combine the factors of demand and supply side to determine household's access to formal credit

Most of these studies considered access to formal credit as probability that households can get credit, just only the study of Diagne (1999) measured access to credit by two ways as the probability and extent of access to credit This study will apply two ways of measuring access to formal credit because it aims answering why some households get credit while the others do not and why households get different credit loan amount as noted earlier in the problem statement

So, the final suggested model is as follow:

Dependent variable = f (HC, PC, FC)

Where:

HC: vector of household head characteristics

[2.8]

PC: vector of household production characteristics

FC: vector of household financial characteristics

• Dependent variable is DLOAN in logistic model:

DLOAN = I if household has outstanding bank loan (or household can access to formal credit sector)

2.5 CHAPTER REMARKS

This chapter built the theoretical framework by examining and analyzing each factor one by one that affect on credit demand and credit supply, then jointly combining to estimate the determinants of household access to formal credit As mentioned above, the interest rate mechanism does not work well because the credit market is imperfect Other factors, excluding the interest rate, will determine household's access to formal credit sectors Through different approaches and the credit model explore factors affecting household's access to formal credit and determining factors from both demand and supply sides are jointly considered through household's characteristics The household's characteristics, production characteristics and financial characteristics expresses both demand for credit and creditworthiness in the lenders' perception, which in tum determine the access to formal credit The household's characteristics, including the household head characteristics, are age, gender, education of household head, member in a household, the poor (household is poor or not), The production characteristics may consist of working for wage/salary, working in sector of agriculture and business or trading The financial characteristics comprise consumption capacity, housing condition (house value and house owning), purpose of loan

By analyzing the combination of theories about the credit demand with credit behavior

of households and credit supply with credit behavior of credit suppliers; the household

economics suggested that the main determinants of access to formal credit in credit demand side include household assets, production assets, real estates, age, education, political and social position of household heads, investment and consumption expenditures, production characteristics, household incomes, and in credit supply side include purpose of loan, collaterals, capital, incomes and assets of borrowers, land areas, age, education level, occupation, skill, health, political and social position and incomes of households, education level, sex, age, occupation, skill, political and social position, All of these factors will have effects on household's access to formal credit The available data of VHLSS 2008 consists of the information of these factors The data can be drawn from VHLSS 2008 includes household head's age, the degree that household head obtained (or we can say education of household head), total number of members in a household, household is poor or not in 2007, working for wage/salary, household's production or service planting breeding, forestry or aquaculture, households do trading or business, consumption capacity, housing condition (house value and house owning), gender of household head, purpose of loan These variables can be employed

to answer the research question

Different studies used different econometric methods to estimate the effects of households' characteristics of access different credit sources These methods can be generally divided into two methods, combination or separation the effect of demand and supply factors Most of these studies considered access to formal credit as probability that households can get credit, just only the study of Diagne ( 1999) measured access to credit by two ways as the probability and extent of access to credit This study will apply two ways of measuring access

to formal credit because it aims answering why some households get credit while the others do not and why households get different credit loan amount as noted earlier in the problem statement By using the logistic model or OLS method, my thesis will jointly combine the factors of demand and supply side to determine household's access to formal credit with the suggested model is as follow Dependent variable = f (PC, HC, FC) (where Dependent variable

is DLOAN in logistic model and LOANAMOUNT in OLS model to determine households' access to formal credit

Chapter 3:

FINANCIAL SYSTEM AND ACCESS TO FORMAL CREDIT BY

HOUSEHOLD URBAN IN HO CHI MINH CITY

This chapter will investigate the overview of financial system in Vietnam, borrowing

by household urban and influence of household, production and financial characteristics on access to formal credit in sectors Ho Chi Minh City

3.1 FINANCIAL SYSTEM IN VIETNAM

A well-functioning financial system is likely to contribute to economic growth and economic development by mobilizing the financial resources and allocating them efficiently The 1988-1989 the government initiated the banking reforms that transformed from mono-banking system into two-tier banking system The process of reform led to diversification of the financial system By this way, the number of credit intermediaries sharply increased Here are some components of Vietnam financial system such as formal credit sectors including state-owned commercial banks, representative offices and branches of foreign banks, foreign joint-venture banks, domestic joint-stock commercial banks, people's credit funds and cooperatives, non-bank financial institution such as finance and insurance companies, stock market, and informal credit sectors including commercial (professional moneylenders, input or output traders, and landlord, ) and non-commercial lenders (relatives and friend, some self-help groups, and rotating savings and credit associations, ) Many kinds of credit intermediaries with different scales contributed to the variety of needs for economy (Nguyen ThiKimThanh,2012)

Among that, for the formal credit sectors, state-owned commercial banks have dominated role in the Vietnam financial system Because the state-owned commercial banks play an important role in the banking system as well as in the economy, the government acts

as a guarantee for state-owned commercial banks when they get in trouble by refinancing the banks, selling government bonds to the public, printing money That's a reason why the government has been decisive in the allocation of the credit form the state-owned commercial banks Theses banks are required to allocate a significant share of the credit to state-owned

enterprises (SOEs) with favor interest rate and without collateral because it is as a matter of policy rather than because the loans are profitable This policy reflected the fact that the government has remained in favor of leading role for SOEs and brought into the bank's portfolios a high share of non-performing loans and this also led to the moral hazard problem This means that other enterprises, households and so on which are more efficient than SOEs may receive only a small ratio of the credit from the formal credit sectors The credit from the state-owned commercial banks becomes an important instrument to help inefficient SOEs to survive Any financial deterioration of SOEs will create difficulties for the banking system because they can not repay the previous loans if the SOEs failed (Le Khuong Ninh, 2003)

The lending procedure is mainly applied to the private borrowers, especially for the household, this aims to select the creditworthy borrowers The lending procedure in Vietnam

is as follow (VBARD, 2011) Bank officers receive loan application forms from the applicant After receiving loan application forms, bank officers report to the head of the credit department The head of the credit department assigns a bank officer to examine the loan application forms to see if it is filled in properly The assigned bank officer appraises the information of the applicant, mainly based on the collaterals The assigned bank officer informs the head of the credit department about the applicant The head of the credit department assesses the information and report to the director of the bank The director of the bank decides the loan amount and informs the head of the credit department The head of the credit department informs the assigned bank officer about the decision The assigned bank officer informs the applicant and the treasury department will disburse loans to the applicant if accepted

In Vietnam, households are required to have collateral assets for loans The collateral may be in kind of land or house (real estate), deposit account some movable assets such as equipments; inventories are sometimes not accepted as collateral The process of providing use-right certificates (for land, house) in Vietnam now takes a lot of time and complex procedure Some households have no use-right certificates and have no chance for loans from formal credit Some households have use-right certificates, however, banks often undervalue the collateral assets, and thus decreasing the loan amount that household can borrow Besides,

collateral make banks spend more cost or resources to assess the collateral So, these banks may tend to maintain the strict lending procedure and require collateral which limit the access

of household to formal credit sectors (Le Khuong Ninh, 2003)

Although the process of reform led to diversification of the financial system, the number of credit intermediaries sharply increased and banking credit increased significantly, the financial system still has some weaknesses Firstly, the credit market is weak competitive, the state still directly interfere the operation of the banking system, extension of credit is biased toward priority sectors and some priority loans are given to State-owned Enterprises (SOEs) which are not competitive and characterized by inefficient productions Secondly, the interest rate has been strictly control by the government Thirdly, the inefficient operation of the banking system and the weakness in the banking system lead to inaccurate evaluation of feasibility of projects and collateral value (Jansen, 2007)

In Vietnam, the informal credit sectors is co-existing with the formal credit sectors and fill in the gap left by the formal credit sectors Although the size of this sector is very difficult

to measure, it is considerable The informal credit sectors include professional moneylenders, relatives and friends and neighbor (Nguyen Thi Kim Thanh, 2012), The relationships among the informal credit sectors are very various, including relationships between households and private moneylenders or input suppliers or output commercial partners or friends or relatives

or neighbors The credit can be in form of cash, gold or dollar and so on The lending can be with or without written or verbal contracts By calculating the data extracted from VHLSS

2008, the interest rate of informal credit sector is very high (in case of individual creditor by 5%) or relatively low (in the case of friends and relatives by 0.33%) And the loan duration can be over night or one day or some days or some month or even years The loan can be with

or without collateral

In short, the main formal credit sectors for households are government banks, private banks, state-owned commercial banks, joint-stock banks, social policy bank, employment support fund, credit organizations, social political organizations, and some special and government microfinance programs The informal credit sectors include private moneylenders,

relatives and friends, and others and these networks still operate together with formal credit sectors

3.2 OVERVIEW OF ACCESS TO FORMAL CREDIT BY HOUSEHOLD URBAN IN

HO CHI MINH CITY

As mentioned above, the household's characteristics, production characteristics and financial characteristics expresses both demand for credit and creditworthiness in the lenders' perception, which in turn determine the access to formal credit and loan mount The household's characteristics, including the household head characteristics, are age, gender, education of household head, member in a household, the poor (household is poor or not), The production characteristics may consist of working for wage/salary, working in sector of agriculture and business or trading, The financial characteristics comprise consumption capacity, housing condition (house value and house owning), purpose ofloan, Factors can be extracted from data of VHLSS 2008 Now we analyze these factors to consider the determinant of access to formal credit and loan mount

3.2.1 Formal and informal credit sources are co-existing

There have been some urban credit needs not satisfied by the formal sectors So, the informal credit sectors could undertake the others The rate of borrowing of urban household

by source in Ho Chi Minh City is described in Table 3.1

Table 3.1 -The average loan amount, by source of loan

2 Agricultural and rural development Bank 10.000 4,84% 0,66%