An analysis of access to formal credit of the households in rural areas

The results of regression indicates that some variables such as poor household, real per capita expenditure, purpose of loan, house own, household head's education, farm size and interes

VIETNAM-NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

AN ANALYSIS OF ACCESS TO FORMAL CREDIT OF

THE HOUSEHOLDS IN RURAL AREAS

The case of the Mekong River Delta

BY TRAN THI THU HONG

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, December 2012

VIETNAM-NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

AN ANALYSIS OF ACCESS TO FORMAL CREDIT OF

THE HOUSEHOLDS IN RURAL AREAS

The case of the Mekong River Delta

A thesis submitted in partial fulfillment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By TRAN THI THU HONG

Academmic Supervisor

DR TRAN TIEN KHAI

HO CHI MINH CITY, December 2012

ACKNOWLEDGEMENTS

First of all, I would like to thank for my teacher, Dr Tran Tien Khai who has taught me methodically conduct research, for his encouragement, and guidance during the completion of this thesis

I would like to express my appreciation towards the teachers and staffs of

V~etnam-Netherlands Program, for the knowledge that I received throughout the years This knowledge helped me to complete thesis

Finally I would like to thank my family, my husband who have encouraged and hctlped me very much in my study

ABSTRACT:

This study attempts to find out what are the main determinants that affect the access to the formal credit sector of the households live in the Mekong River Delta with the data extracted from VHLSS 2006 and 2008 To fulfill the research objective, this study relies on the function of credit given to a household of M.H Quach, A W Mullineux, V Murinde (2004) With the helpings of Stata- 9 and Stata -11 software, the logistic model and Ordinary Least Squared method are employed to explore the main factors that can be used to measure households' access to formal credit sector by the possibility of getting credit or not and the loan amount that households got from the formal credit sector The results of regression indicates that some variables such as poor household, real per capita expenditure, purpose of loan, house own, household head's education, farm size and interest rate have significant effects on households access to formal credit Therefore, in order to broaden the access to formal credit of the households in the Mekong River Delta as well as Vietnam, the banking system and

TABLE OF CONTENTS Acknowledgements : 11

Abstract

··· iii

Tables of contents iv

List of abbreviations • •.••.• •.• • •.•.• •.• • • • • • •• •.• Vl · List oftables and figures ··· v1 ·1· CHAPTER 1: INTRODUCTION 1 2 3 4 5 Problem statement 1

Research objectives 3

Research questions 3

Research hypothesis 3

Data sources and methodology 4

6 Scope and limitation of the research 4

7 I Structure of the thesis 5

CHAPTER 2: LITERATURE REVIEW I 2.1 Definitions , 6

2.1.1 Households and households in rural areas 6

I 2.l2 Formal credit versus Informal credit 6

I 2.1.3 Micro finance and Access to credit 7

2.2 Theoretical framework related to determinants that affecting to the formal credit by rural households : 8

2.2.1 Traditional approach - the dominant paradigm in the 1950s- 1970s 9

2.2.2 Financial repression approach 10

2i.2.3 New institutional economics approach 12

2.2.4 Conclusions ofthree approaches 13

2.3 Credit market model : 13

2.3.1 Households' borrowing behavior and the Demand for Credit 15

2.3 2 Credit supply and behavior of formal lenders 17

2.4 Empirical studies related to the determinants that affecting to the formal credit by rural households · · · 19

2.4 1 The household charact~ristics 20

2.4.2 The lender characteristics 23

2.4.3 The location characteristics or the availability of the formal funds 24

2.4.4 The local market characteristics 24

I 2.5 Chapter remark 24

CHAPTER 3: RESEARCH METHODOLOGY26 3 1 Methodology 26

~.2 Model specification 26

CHAPTER 4: FINANCIAL SYSTEM AND ACCESS TO FORMAL CREDIT BY HOUSEHOLDS IN ME~ONG RIVER DELTA 4.1 Rural financial system in Vietnam 30

4.1.1 Overview of rural financial supplier 30

a The formal sector 30

b The semi-formal sector 32

c The informal sector : 33

d Summary 34

4.1.2 Some weakness and challenges ofthe rural financial system 34

a Weakness of the financial system 34

b Rural finance challenges 37

4.2 Households in the Mekorig River Delta 39

4.2.1 General picture of the Mekong River Delta 39

4.2.2 Rural financial system in the Mekong River Delta 41

a Households characteristics 41

b Production characteristics 43

4.2.3 Credit characteristics 44

a Credit sources 44

b Interest rates 4 7 c Loan size 49

d Aim ofborrowing and uses of loan 50

e Lending procedures and collateral requirement 52

f Information problem of banks with respect to households 54

4.3 Summary 54

4.4 Determinants of credit accessibility of households in Mekong River Delta 55

4.5 Chapter conclusions 61

CHAPTER 5: CONCLUSION AND POLICY IMPLICATION 5.1 Conclusion 63

5.2 Policy implication 64

5.3 Research limitation 66

References 67

Appendices 7 4 LIST OF TABLES Table 3.1: Table of independent variables 29

Table 4.1a: Household's size, householder's age and real expenditure per capital (with VHLSS 2006) • 41

Table 4.lb: Household's size, householder's age and real expenditure per capital (with VHLSS 2008) 42

Table 4.2a: Education level of household head (with VHLSS 2006) 42

Table 4.2b: Education level of household head (with VHLSS 2008) 42

1 Table 4.3a - Typology of credit sectors and lending characteristics in MD (wi th VHLSS 2006) 45

Table 4.3b - Typology of Credit sectors and lending characteristics in MD (with VHLSS 2008) 45

Table 4.4 a- Source of the rural credit in classifying poor or not poor (with VHLSS 2006) : 46

Table 4.4 b- Source of the rural credit in classifying poor or not poor (with VHLSS 2008) ··· 46

Table 4.5a- Sources of the rural credit in interest rates (with VHLSS 2006) 48

Table 4.5b- Source of the rural credit in interest rates (with VHLSS 2008) 48

Table 4.6a- The average loan amount of the poor households (with VHLSS 2006) 49

Table 4.6b- The average loan amount of the poor households (with VHLSS 2008) 49

, Table 4.7a- Loan uses by wealth categories (with VHLSS 2006) 50

Table 4.7b- Loan uses by wealth categories (with VHLSS 2008) 51

Table 4.8a: Collaterals require)llent in two sectors (with VHLSS 2006) 54

Table 4.8b: Collaterals requirement in two sectors (with VHLSS 2008) 54 Table 4.10a: S~multaneous equat~on models w~th VHLSS 2006 56 table 4.10b: Simultaneous equatiOn models w1th VHLSS 2008 60

LIST OF FIGURES

Figure 1: The vicious circle of capital formation 10 Figure 2: The commercial banks' lending procedure 52

ABBREVIATIONS

MFis: micro-finance institutions

NGOs: non-governmental organizations

LUCs: Land Use Certificates

VBARD: Vietnam Bank of Agriculture and Rural Development

VBP: Social policy Bank

GDP: Gross Domestic Product

MD: Mekong River Delta

RD: Red River Delta

CHAPTER 1: INTRODUCTION

1 Problem statement

Vietnam is regarded as the rapid growing economy in the world The average growth rate of GDP in the period 2000-2008 is about 7.4%/year, in 2009 is 5.32% and in 2010 is 6.78% With 75% of the population live in the rural area, agricultural production accounts for 22% of GDP, 30% of exports and 60% of employment The Mekong River Delta (MD) is one of the two main agricultural production regions in Vietnam In the early 8 months of the year 2011, MD has export 4.1 million tons of rice, account for 90% of rice export of all the country, value export

of rice is above 2 billion USD However, the rate of the poor ofthis region in 2010

is very high, accounts 18.85% the poor households of the country, the income is about 975 USD/person/year, very low in compared to income 1,160 USD/person/year of the country

It is found that "limited access to available resource including financial capital, is

among the main underlining causes of poverty in Vietnam Microfinance is a key part of such resources from which the poor can choose and develop better livelihood" (UNDP, 1996) Morduch and Haley (2002) also found that when the

poor get access to credit, they can "improve their productivity and management

skills; create jobs, smooth income flows and consumption costs; enlarge and diversify their businesses; and hence, their income can be increased and they have

a better conditions on taking health care and education "

Since in 1997, the Vietnamese government has launched the Hunger eradication and Poverty Reduction concentrated on improving the poor's access to credit, especially

in the rural areas The major institutions do that mission are Vietnam Bank for Agriculture and Rural Development (VBARD), Vietnam Bank for the Poor (VBP) and People's Credit Funds (PCFs) Through credit programs, they provide loans to poor households at subsidized interest rates However, they have failed to provide sustainable and large extent access to credit to the poor and be sustainable credit institutions According to Stijn Claessens (2005, page 2), the main reason of this

problem is that "the financial system does not cater to the demand of all customers

Banking systems and capital markets are often skewed towards those already better off, catering mainly to large enterprises and wealthier individuals while many segments of the enterprise and household sector suffer from lack of access to finance, hindering their growth and welfare"

Quach Manh Hao, A.W Mullineux and V Murinde (2004) found that "providing credit in particular and financial services in general to the poor has a consistent impact on household poverty reduction", and "in order to help rural households gaining more access to credit, the credit network must be extended to the village lever

Despite the growth and mcrease of formal credit sector, there are still a large number of the poor being excluded from access to formal credit They have to depend on informal credit sector consists of relatives, friends and professional moneylenders with very high lending rates In 2001, 40% of households in Vietnam could not get credit from the formal credit sector In 2011, the interest rates in black credit market is from 18%- 20% per month, it means that if you want to borrow one million Vietnam dong in black market, you have to pay from five to six thousands interest per day

Access to formal credit sector has become an important matter of the overall development in most of countries, especially in developing countries There are so many researches examining the factors that affect the rural poor's accessibility to credit market According toLe Nhat Hanh (2002), there are four main determinants affect to the rural households' access to formal credit:

The first determinant that constrains the access of the households to the formal credit is lack of collateral while collateral is the prerequisite for borrowing money from the bank

The second determinant is the land area and the land certification status, when the households have the large farms and its titles, the access to formal credit will be extensive and smooth to them

The third determinant is the educational level of the household, when the

households have the high certificates, they have ability to make profit investments and dealing with complex borrowing procedures easier

The forth determinant is the production scale and cycle, with larger production, the households have the higher probability and scale to get formal credit and the households will choose the short-term credits or long-term credits that suitable for their production cycle to borrow

With the boom of the financial market in 2008 last to now, the banking system of Vietnam has showed its weakness The most of credit is supplied to the stock market, gold market and land market, while the material production area is lacked

of capital That is because of this area does not have the high rate of returns in the short investment time Therefore, the thesis will based on these findings to answer the question that why a large number of the households do not get access to the formal credit concentrating on the households living in the big rural area: the Mekong River Delta The thesis will also find out some specific policies could be apply to improve the access to the formal credit to this region

the household, the age and gender of the household head, the complicated procedures of the formal credit institutions, etc

5 Data sources and methodology

Data sources

The analyses will be conducted based secondary data and tertiary data Secondary data collected from the latest data set - VHLSS 2006 and VHLSS 2008 (The Vietnam's Households Living Standards Surveys), so the data set does not reflect the variation or fluctuation of the economic - financial environment in the recent years This survey was implemented by General Statistics Office (GSO) with funding from Swedish International Development Cooperation Agency (SIDA) and UNDP, and technical assistance from World Bank (WB)

Tertiary data collected from various sources, including theses of VNP (Vietnam Netherlands Program) students, working papers and papers on the Internet and in the VNP library

-Methodology

This research will start with cleaning data process In this process, some missing observations, which are represented to households having no demand for credit, are eliminated, only household want to borrow money from the bank are kept Descriptive statistic and econometric methods will be used to analyze in order to draw a general picture of the Vietnam rural credit markets, household characteristics and others fundamental issues related to the access to the formal credit Stata-9 software and Stata-11 software are used for VHLSS 2006 and VHLSS 2008 analyses to find the main determinants that have strong effects to access to the formal credit of the households live in the MD Logit model is used in this thesis As a result, the matter can be solved in quantitative and qualitative methods

6 Scope and limitations of the research

The research will concentrate into the households live in the Mekong river delta There are 885 observations were analyzed in VHLSS 2006 and 856 observations

were analyzed m VHLSS 2008 Therefore, the results will be qualified appropriately

7 Structure of the thesis

The research starts with the introduction part After reviewing the literature in Section 2, Section 3 is devoted to methodology Section 4 provides an overall picture about the rural credit market in Vietnam, and the characteristics of the rural credit market of the MD in specific It is also used for interpreting the regression results and Section 5 summaries of findings and discusses some key policies that suitable for the region

CHAPTER 2: LITERATURE REVIEW 2.1 Definitions

2.1.1 Households and households in rural area

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

Behavior of households in credit market: the households lacking in materials need

to borrow while the households abundant in materials want to lend out for earning interest Therefore, credit market is born to facilitate the need and the want of these households Credit market has function to transfer materials from abundant households to lacking ones

Rural finance: refers to the supply of financial services for people live in the rural area and they are working in agricultural production and/or doing small business Rural finance includes formal, informal and semiformal credit sectors with different kinds of products and services such as loans, deposits, payment services, money transfers and insurance (Geetha Na Garajan & Richard L Meyer, 2005)

2.1.2 Formal credit versus Informal credit

Formal credit: Ghate ( 1992) defines formal financial market is a place where financial activities that are controlled and monitored by government This marker is much more developed in the urban area than in the rural area with many bank branches and animated activities

Informal credit: In developing countries, the main reason for the existence of the informal credit sector is the underdevelopment of the formal credit sector

In contrast to the formal credit sector, the informal credit sector supplies credit for people who need loans with much easier requirements The reason is that borrowers and lenders often live in the near places, and know each other before Therefore, in order to maintain the trust and the relationship with lenders, borrowers make every effort to repay Moreover, instead of requiring collateral or documents (such as red

certificates, stocks, bonds, etc), lenders usually use informal laws to obligate or threaten borrowers to repay Although moneylenders usually exploit the borrowers

by giving them short-term loans with high interest rates that may lead to their unable repaying situations, moneylenders still play a significant role in the informal credit sector (Aleem, 1990)

2.1.3 Microfinance and access to credit

McCarty (200 1) defines micro finance is lending and saving activities in small-scale

of households in the rural area

According to ADB, microfinance plays an important role in reducing poverty Facilitating access to microfinance can help the poor to cover their expenditures, performed their businesses, hence, increase their income, and improve their lives Some main activities of micro finance are: loans, deposits, payment services, money transfers and insurance

Three sources ofMicrofinance

• formal institutions (rural banks and cooperatives)

• semiformal institutions (non- government organizations NGO)

• informal sources (money lenders and storekeepers)

Microfinance is most often provided by non-bank institutions such as NGO Microfinance institutions are often based on the group-lending approach

Financial exclusion: is a process that the formal credit sector performs to prevent

borrowers from getting credit (John D Conroy, 2004)

A repressed financial system: is system where the government sets the interest rate

at a level below the equilibrium interest rate of the market This rate is negative because it is smaller than the inflation rate (McCarty, 2001)

Access to credit or access to finance: "refers to the availability of supply of quality financial services at reasonable costs" (Stijn Claessens & Konstantinos Tzioumis, World Bank, 2006) Jan Van Heeswijk presented in the Access to finance

International conference in 2004 that "Despite a proliferation of financial

institutions in many countries, limited access to quality financial services remains a

challenge across the region" Quality here means financial services that are

supplied reliably, conveniently, continuously and flexibly In some countries, the quality of financial services is not good, it means that the need of credit is limited in scope and carries high interest rates

Developing countries realized the importance of bringing some basic financial services such as deposits, savings, payments, loans, and insurance to the poor households

Diagne ( 1999) said that a household gets access to credit from a certain source credit if it can borrow from that source, even if it do not need to borrow A household has access to credit if the amount of credit it received is larger than zero, and it is constrained if this amount is zero or less than the amount it wants to

borrow The maximum amount of credit it can borrow is called its credit limit

According to Nimal A.Fernando (2007), a person who has full access to the formal financial services when he wants to use it and he is able to use it

Access to finance is a problem that only can be solved effectively by both financial and non-financial sector measures Some non-financial sector measures are improvements in education, infrastructure, basic health care and other essential services

2.2 Theoretical framework related to determinants that affecting to the formal credit by rural households

Credit rationing: refers to the circumstance where the lenders lend their money at the amount lower than the amount they can supply regardless of the high interest rate the borrower can pay for them This is an inefficient situation of credit market (Stiglitz & Weiss, 1981)

The lender's credit rationing behavior is based on the characteristics of borrowers, the expected returns of the project, the terms of the loans, and the imperfections of credit market If the principal plus interest of the loan higher than the expected return, the probability of default will be high, the lender will provide a smaller

credit amount than the amount that the borrower want to borrow, or even the lender reject to provide credit

Interest rate acts as price of credit and tool for controlling risks When there is an excess demand for credit interest rates will increase, so the lender's income increases which offsets greater risk When interest rate is low and funds are rationed, it is called that credit rationing without the possibility of rising interest rates (Nathan Okurut, Andrie Schoombee & Servaas van der Berg, 2004)

Now, we review three theoretical paradigms to show a picture about the operations

of the formal and informal credit sector as well as the process of making decisions

of households

2.2.1 Traditional approach- the dominant paradigm in the 1950s-1970s

This approach develops the Keynesian views on the role of the government It supposed that in developing countries, the lack of capital fund is the main problem restraining the household access to formal credit sector

From the supply side, governments supplies credit for agricultural production at

subsidized interest rates (this rates are often less than the inflation rate) This approach concentrated on the effects of the constraints in the rural financial environment instead of reducing them This approach supposed that in the rural area, the potential savings was too low for formal credit sector mobilizing or offering savings facilities In order to break down the vicious circle of capital information in the rural area, the government should pump external funds to develop investment, should not established agricultural credit organizations to provide credit for consumption needs (Doug Pearce, 2004)

From the demand side, this approach supposed that the borrowers are very sensitive

any changes of interest rates, if the interest rate reduced, households can apply new technologies to their production and make their investment more productive The government should intervene into the credit market by using credit policies such as interest rate ceiling and interest rate subsidies in order to provide cheap credit to the households

However, the traditional approach has some weakness: Subsidized credit programs did not contribute much to the agricultural growth There were only the large-scale farmers and wealthy households had access to formal credit, the rest had to go to the informal sector Therefore, the government policies have been distorted and the growth of credit market has been repressed (Doug Pearce, 2004)

~ The traditional approach suggested that the governments in developing countries should apply low interest rate policies, and concluded that land size and consumption characteristics might be important determinants of households' access

to formal credit

Figure 1: The vicious circle of capital formation

Low productivity

a

Low investment rate

Low per capital income

Source: http://www.economicsconcepts.com/nurkse's model of vicious circle of poverty (vcp).htm

2.2.2 Financial repression approach

The financial systems approach assumed that the institutions adhering to commercial principles could achieve extensive outreach and sustainability The government should ensure the favorable environment to the growth of such institutions; financial institutions and credit programs should satisfy the household demands for credit solidly and flexibly

This approach appreciates the role of the formal sector, and informal sector cannot replace the formal sector This approach also supposed that liberalization in financial system would deepen and improve the financial efficiency, hence, shorten the gap between the rates of bank deposits and the interest rates, increase the flow

of capital between segments, restrain the development of informal credit sector and

broaden the access to formal credit sector in developing countries (McKinnon, 1973

& Shaw, 1973)

It is hard to provide credit for agricultural production because it needs arrangements that are more flexible So, lenders favor in lending to larger borrowers than to a larger number of small borrowers in order to minimize the lending costs (Donald, 1976) Besides that, formal financial institutions were abused to provide credit at subsidized interest rate to borrowers who have political or social position (Von Pischke, 1983) In many developing countries, MFis introduced flexible and more

accessible savings facilities (product innovations) for borrowers in order to reduce

the risk of seasonal income shortfalls; used technology such as cash machines,

mobile phones (mechanism innovations) to reduce costs and expand the rural financial services; used model of village bank-type (institutional innovations)

Implementing these changes and innovations can improve the formal credit sector (Doug Pearce, 2004 )

Some weakness of this approach:

The problems about the underdeveloped market and asymmetric information in the rural credit market such as moral hazard and adverse selection were not addressed

in this approach The formal credit sector was willing to charge the high interest rates instead of solving the information problems These high interest rates do not reflect the scarce funds but the high information costs

This approach supposed that the governments should keep the extension of the financial and banking sectors under their control in order to increase revenues from other channels

In conclusion, the financial repression approach suggested that the governments in developing countries should apply high interest rate policies to encourage savings, and hence, creating opportunities to invest in agricultural production This approach concluded that loan size, the social position and political position maybe affect household access to formal credit The credit allocation may result from government intervention and rational behavior of lenders and borrowers

2.2.3 New institutional economics approach

Similar to the financial repression approach, this approach also supports the credit market is imperfect The difference is that, credit allocation 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

In credit market, asymmetric information arises when the lenders do not have enough reliable information about the borrowers' potential risk of default (Aleem, 1990) Because the collection of reliable information takes a lot of time, money human resource, so the lenders compensate for these costs by increasing the interest rates, resulting in adverse selection and moral hazard Finally, the lenders cannot reach higher expected return because the average riskiness of projects is high and the chance to make repayment is low (Nathan Okurut et al., 2004)

Adverse selection arises where borrowers with low profitability projects but safe might hesitate to borrow because their profit might not cover the high cost of borrowing while riskier projects with higher potential profits and probability of default are attracted into the market, which in turn reduces the profitability of lending operations (Nathan Okurut et al., 2004 )

Instead of increasing the interest rate, lenders can use other screening devices such

as character assessment, collateral requirement to lighten the adverse selection problem, if not, they can reject loan applicants (Thorsten Beck & Augusto de la Torre, 2006)

Moral hazard occurs where projects with low risk change to higher risk and returns projects To solve this problem, lenders usually design credit contracts with provisions that tie the borrowers to do their bets efforts that enhance the ability of repayment as well as attract low risk projects (Nathan Okurut et al., 2004)

Lenders may also choose non-price devices or reduce the loan amount in order to lighten moral hazard problems (Thorsten Beck & Augusto de la Torre, 2006)

Because of adverse selection and moral hazard, lenders use non-interest rate mechanism to allocate credit They assess borrowers' riskiness basing on household

observable characteristics: land area, housing conditions, main occupations of household head, education and reputation of household before deciding whether to accept or reject the loan application Borrowers who have reliable information to ensure that they will use the loan wisely and make repayment in time will have larger access to formal credit of household

The institutional approach also supposed that other approaches neglected the

transaction cost that is paid by the borrowers for completing the borrowing requirements such as transportation costs - beyond the interest rate Although interest rate is low, transaction costs maybe restrain the poor access to the formal credit institutions In the rural area, agricultural activities accompanied with high risks and low average returns, informal sector depends on personal and localized information Although informal sector has a monopoly power, it is hardly for this sector to expand its activities (Stiglitz, 1992)

This approach suggested that household observable characteristics: land stze, household assets, main occupations, education and reputation of household head might affects access to credit of farm households

2.2.4 Conclusions of three approaches

There are many determinants that affect the households' access to formal credit such as land size and consumption characteristics (traditional approach), loan size, the social or political position (financial repression approach), household assets, main occupations, education and reputation of household head (new institutional economics approach) Hence, in order to analyze the households' access to formal credit in the rural area, it is necessary to consider the above determinants thoroughly

2.3 Credit market model

There is a significant difference between access and usage of financial services

Access is the possibility to use while use is the actual use of financial services A person may have access to a financial service, but he can decide not to use it

Inversely, a person may want or need a financial service, but he does not have access to it (Genesis Analytics, 2004 )

Access has many dimensions: services need to be available when desired and tailored to specific needs; the prices for these services need to be affordable; credit resources should not be limited to borrowers; provision of these services should bring forth profits for the lenders, and therefore be available on a continuous and sustainable basis Therefore, it is difficult to measure access (Asli Demirguc-Kunt, Thorsten Beck & Patrick Honohan, 2006)

Credit can be considered as a commodity, the price of credit (interest rate) will determine both demand and supply side It means that both of the borrower's choice and the lender's decision have effects on household access to credit simultaneously

A credit market is characterized by limited supply but excess demand (Nathan Okurut et al., 2004)

Patrick Honohan (2004) proposed that considering the access to finance on both sides:

The demand side: includes the contribution of getting credit to household welfare The supply side: includes cost conditions and other barriers to access There are

three barriers to access:

* Price barriers: includes the price charged by the formal credit institutions (this part related to technical efficiency, regulatory, tax factors and competition), and the additional costs the households have to pay in accessing this service (such as costs for transportation and communication infrastructure)

Price barriers are used to measure the level of using the financial services

*Information barriers: increase the cost of credit and restrain a certain number of households in getting access to formal credit Information barriers raise credit rationing too

Reforming and finishing procedures and laws relating to activities in the credit market can help reducing the need for information

*Product and service design barriers:

Products and services that are offered by the formal credit sector are unadapted with the household demands The main reasons are the terms of payment of the loan contracts may not suitable for the borrowers' cash flow patterns, or the small savings of the households in the vast rural areas are hardly to collect because of lacking of branch locations, the cumbersome administrative procedures that raising borrowers' transaction

Now we examine the demand for credit and the supply of credit, as well as the behaviors of both borrowers and suppliers in the rural credit market

2.3.1 Households' borrowing behavior and the demand for credit

Households have access to credit may or may not be credit restrained Households are credit constrained when they cannot get the amount of credit they need at the current interest rate, nor they can get credit at a higher interest rate With limited access to credit, households have to regard carefully how to invest, what inputs to buy for production (Nguyen Thi Thu Phuong, 2006)

Quach Manh Hao et al., (2004) assume that household i in location j at time k During the period from k-1 to k, this household would have a demand for credit rdijk function:

where:

• IIijk is household characteristics vector such as: gender of householder,

initial endowment, number of years of education of household head, etc

d

• Q ijk is location characteristics vector such as index of location goods

prices, the prices of selected goods and services, etc

d

• <I> is market conditions vector such as the price of credit and the

mechanism by which credit is distributed, competition among borrowers etc

d

• 8:J is unobservable characteristics of household and location vector such

as the human effort and dedication

Credit demand for long-term investment requires long-term and large loans while short-term and small credits are suitable for short-term investment In rural areas, households mainly invest in expanding production such as buying or renting additional land, new machineries and applying new technologies Credit demand is also for consumption in urgent cases such as ill, funeral, diseases, natural calamity, etc (Ray, 1998)

Households has stronger political and social position (have closed relationship with bank staffs) will have much more knowledge and information about credit programs, so they can apply for formal credit easily and early (Donald, 1976)

Households with high level of education will have more access to formal credit Because they have better investment plans and can solve the complex loan procedures easier Moreover, richer households have lesser demand for credit because they have stronger financial capacity Young households with more children might borrow more to satisfy their larger consumption demand (Kooreman

et al., 1997)

The determinants that affect to the households' demands for credit are: household incomes, household assets, investment and consumption expenditures, production characteristics and other important characteristics such as age, education, political and social position of household heads

2.3.2 Credit supply and behavior of formal lenders

Nathan Okurut et al., (2004) found that credit supply is constrained by the available demand for credit, especially in the case the price of credit (interest rate) is perceived to be high They also found that the banks will only serve the poor for profit, and the government should provide incentives for banks such as subsidies, tax remission or giving supports for banks at least to cover their costs, hence, the banks can provide credit to a large number of households

Banks perform three steps to reduce risks that may happen in the process of lending:

screening potential borrowers to determine defaults; helping borrowers to fulfill their credit contracts; and diversifying enforcement actions to recover the loans and interests Because of the asymmetric information problems, banks usually require collateral to determine creditworthiness, solve the incentive and enforcement problems However, the poor are often out of the way accessing to the credit because of the collateral problem and high transaction costs Banks are often not conveniently located, pay high salaries for high - skilled personnel, and bear costs of standardizing procedures for transactions While thee poor clients also spend a lot of time and money in dealing with banks So, banks failing to meet the credit demand of the poor (Nathan Okurut et al., 2004)

According to Quach Manh Hao et al., (2004 ), the supply of credit rsijk governs the credit that the household can access to:

where:

• Y is a vector of lender characteristics (lender is formal or informal,

non-profit or for-non-profit, available funds or not available funds, etc)

s

• n is location characteristics vector

• <I>s is market conditions vector (the lenders' competition, mechanism, etc)

s

the local comparative advantage, etc)

The credit rationing mechanisms appears to be a combination of selection of both borrowers and lenders (due to the high costs of borrowing, the borrowers do not want to borrow or borrow at the credit amount less than the offered amount; lenders decide not to lend all of the requested amount) Some observed socio-economic variables such as household size, education of householder, household expenditure and household assets (not including land) have possitive and significant effects on credit supply (Nathan Okurut et al., 2004) Education, health, age, occupation, skill, incomes and assets of borrowers have effects on banks' perception about households' creditworthiness

In the formal credit sectors of the developing countries, credit supplies are always smaller than demands, so the banks have to allocate the limited loans among credit applicants, and are likely to choose to serve borrowers who have enough information verifying that the provided credit will be used wisely and make profits for banks (Moll, 2000)

With low interest rate, the banks overemphasize on collaterals, land areas and political and social position of households Hence, large borrowers will be accepted easily for credit when they have enough collateral (Donald, 1976) Ladman (1984) supposed that a loan with low interest rates does not mean that households want to borrow Otherwise, the total cost of borrowing, not the interest rate, is the main factor that affects to households' decision If the households need small loans, they often choose to borrow from lenders maybe charge high interest rates but low transaction costs If households need larger loans, they may choose to borrow from lenders who charge higher transaction cost but lower interest rate Therefore, rural credit market is characteristics segmentation

The determinants that affect to the households' supply credit are: education level, sex, age, occupation, skill, political and social position, collaterals, capital, incomes and assets of households, etc

According to Quach Manh Hao et al., (2004 ), the function of credit given to a household rijk is:

where:

• n IJ k is household characteristics vector

• Yijk is the contracts characteristics and project quality vector

• nijk is the local characteristics vector

• <l>ijk is the competition of market and availability of funds vector

In summary, the determinants that affect to the household's access to the formal

credit are: households characteristics (sex and age of household head, household

size, dependency ratio, health condition and education level of household head, household's expenditures and incomes, political and social position of household

head, skill and occupation of household head, collateral), lenders characteristics (for-profit or non-profit lender), market conditions (availability of funds, interest

rates, competition among borrowers and lenders, mechanism by which credit is

channeled), location characteristics (convenient location, number of banks), contract characteristics (terms of payment, maturity) and project quality

2.4 Empirical studies related to the determinants that affecting to the formal credit by rural households

As mentioned above, in developing countries such as Vietnam, access to credit is an essential condition for developing the economy People having access to credit mean that they have chance to own an account, to borrow, save, invest and do other things, hence, they have more opportunity to break the chains of poverty

There are many different reasons for people do not having access to credit Therefore, this section reviews some empirical studies about main determinants affecting to households' access to formal credit in the rural areas of developing countries

2.4.1 The household characteristics that are expected to have effects on making decisions of both borrowers and lenders:

a The age of the household head

Older households have poor chances to access to formal credit, because they are always risks averse, afraid of being indebted to lenders Moreover, it is difficult for them to understand the provisions of credit contracts as well as the formal credit institutions' operations Khalid Mohamed, 2003)

Older households often have more savings, out of working age, and do not need to consume as much as the younger, so they may less demand for credit (Vu Thi Thanh Ha, 2001)

However, older households are appreciated by the banks because they have more assets, experiences, reputation and responsibility Therefore, they have larger access

to formal credit (Le Khuong Ninh, 2003 )

b The gender of the household head

Khalid Mohamed (2003) found that gender is a variable has a negative effect on the household's access to the formal credit that means women have lesser chances to get credit from formal credit sector although they were supported substantially in some special credit programs

c The marital status of the household head

Marital status is a variable has no significance, means that a person getting married

or single does not affect the access to credit of that person

d The number of years of education of the household head

According to Quach Manh Hao et al., (2003), rural borrowers with low level of education find difficult in understanding and preparing necessary forms and documents

In theory, the higher level of formal education, the higher possibility of access to formal credit But in reality, many small credit programs favored the poor, especially the poor live in the rural areas, and most of them had low education levels benefited from these programs (Khalid Mohamed, 2003)

Nguyen Huu Cuong (2007) found that the households with highest and lowest level

of education usually borrow least

e The occupational activities

The main occupation is supposed to have effect on access to credit because the type

of activity and investment requirements could affect household's demand for extra money and hence access to credit However, the effect is not significant (Khalid Mohamed, 2003)

f The social or political participation of the household head

Nguyen Van Ngan (2003) found that the social or political position of a household has a positive significant in the formal loan size The reason is that in Vietnam, moneylenders and tontine are considered as illegal credit sources, so the household with any social or political positions may avoid borrowing from these sources and receive formal loans

g Size of household and Dependency ratio

Households with large size or high dependency ratio seem to be having high credit demand but the banks do not favor to lend for them, because they are considered low production capacity and repayment (Nathan Okurut et al., 2004)

h The farm size

The household with large farm usually need more capital for their production, so they have to look for external financing opportunities The variable farm size has e a positive effect on household's access to credit

Moreover, households with higher productivity of land use, which is decided by the type and the position of land, will have more chances to access to formal credit It means that productivity of land use has a positive effect on household's access to credit too

i The ownership of land

Collateral requirement is the main determinant influencing household's access to formal credit Land Use Certificate (LUC) is used as the major collateral, and each

household cannot use the same LUCas collateral for more than one loan at the same time (Quach Manh Hao et al., 2003)

Having a LUC might be expected to increase a household's access to formal credit However Do Quy Toan and Lakshmi Iyer (2007) did not suppose that LUC increased the household's access to formal credit In cases of default, banks are very hard to seize land, partly because regulations were not transparent, and commune officials did not support to transfer lands to people live in the other region

Le Nhat Hanh (2002) found that land area is one of the major determinants of household's access to formal credit Households with the larger farms with LUCs will have the larger loan and in the easier way than the others

j The value of households' assets

According to Diagne ( 1999), the variable composition of assets is more significant than the total value of assets or the land size

Nguyen Van Ngan (2003) also agreed with this argument, he found that the households with high value of assets often have enough money to finance their consumption and investment, so they only borrow small loan and formal lenders do not give loans based on the value of assets too

However, the price of land that is used as collateral is usually evaluated lower than the price of land which is stipulated by the Government (Quach Manh Hao, 2003)

k Income Levels

According to Khalid Mohamed (2003 ), the variable income levels has a negative effect on household's access to formal credit, means that households have better opportunities for getting credit usually are households have low income The reason

is many credit programs targeted to the low-income households in rural areas

I Household expenditure

Nguyen Van Ngan (2003) found that when the expenses of the households increase, they will need more money and so they would apply to get larger size of loan from formal sources But in some cases, the farm households borrow a big amount of money from their friends, relatives or neighbors

m A ware ness

Awareness on credit availability has a positive effect on household's access to credit, means that households have better opportunities for getting credit usually are households have better awareness on credit availability (Khalid Mohamed, 2003)

n The production scale and cycle

Le Nhat Hanh (2002) found that the household's demand for credit depends on the scale and the business cycle of that household The larger production the higher demand for credit; the longer time production cycle the longer term loans, so the higher probability and extent that the household can get formal loans

2.4.2 The lender characteristics: The sources of credit, the purpose of loan for working capital and investment, and the interest rate are significant to the aggregate household credit amount (Quach Manh Hao et al., 2003)

a The sources of credit Banks officials are consultants for borrowers on planning business and loan disbursement However, they are limited in number and have to manage with at least three communes with a varied working schedule (the case of VBARD) Therefore, the borrowers usually have to wait for a long time and spend much of money from the day they applied for credit to the day they received credit

b The purpose of loan for working capital and investment Households usually want to borrow credit to cover their daily needs, however, the banks only accept to provide credit for some specified needs Moreover, many low-income households cannot afford for the expenses such as certification fees, photograph, application form, travel, etc Therefore, they are out of access to formal credit

c The monthly interest rate of loan Lending interest rate is statistically significant to access to formal credit of rural households It means that if the banks increase their interest rate, the borrowers maybe decrease the amount of credit that they want to borrow as least as possible

d The term of loan

The term of credit contract has small effect on household's access to formal credit Longer term of payment maybe leads to larger loan However, the banks are usually

do not want to provide credit with longer term because of the liquidity problem with other things are equal

e The requirement of collateral

The variable requirement of collateral has a positive and significant effect on the amount of credit that the households can get from the formal sector Collateral is used as the screening device for banks In the view of banks, borrowers have more collateral are safe borrowers, and of course they are preferred to provide credit (Quach Manh Hao et al., 2003)

2.4.3 The location characteristics or the availability of the formal funds

Most rural borrowers reside far from banks branches, so they have to take much money and time to go to the bank branches Thus, location of a household seemed

to have effect on household access to credit But in Khalid Mohamed's research, the regression results show that location has no effect on household access to formal credit sector

2.4.4 The local market characteristics:

Competition between borrowers live in the near places is expected to have a negative effect on household access to formal credit, implying that when a household is provided an amount of credit, the others who live in the near place will has more troubles on access to credit (Quach Manh Hao et al., 2003)

2.5 Chapter remark

This chapter developed a theoretical framework to analyze determinants that affect

to household access to formal credit, especially in the rural areas Because the credit market is imperfect, the price or interest rate mechanism does not work well, so other factors, which are divided into four groups, consist of: the household characteristics, the lender characteristics, the location characteristics and the local market characteristics, will do affect on access to formal credit of households

The most important determinants of households' access to formal credit hat both theoretical and empirical evidences supporting are: the farm size and the ownership

of land, the value of households' assets, the production scale and cycle, the social or political participation of the household head, and the household expenditure

CHAPTER 3: RESEARCH METHODOLOGY

3.1 Methodology

There are many studies that used many different econometric methods to analyze accessing to the formal credit of the households in rural area, but the two common methods are the combination or separation the effect of household's characteristics

of access to different credit sources In my study, I will use the effects of demand and supply factors together to measure household's access to formal credit sector by using logistic model and Ordinary Least Squared (OLS) method because the access

to formal credit can be analyzed by two ways In the first way, access to formal credit is a dummy variable with two possible values of getting credit or not In the other way, access to formal credit can be understood as the extent of access to formal credit and can be measured by the loan amount that households got from the formal credit sector

The household's characteristics affect both demand and supply side in the credit market This approach is suitable for determining households' access to formal credit sector basing on the available data in the VHLSS 2006 and VHLSS 2008 So,

it will be used in the thesis

Moreover, I will use the inductive method to analyze the data in the VHLSS in order to generalize the overall picture about MD and its credit activities The deductive method is also used to decide to accept or not accept the assumptions of the main determinants that affect to the household access to the formal credit in the

MD from analyzing the above data

the event of having access to formal credit This dummy receives a one if the household can borrow money from formal credit sector as much as he needs, so he can be said that he has an access to formal credit If the household cannot borrow or can borrow but not enough, the dummy receives a zero, the household in this case can be said that he has no access to formal credit

To examine why households got different bank loan amounts, the OLS method will

be used, and the dependent variable (LA- Loan amount) is the households' bank loan amount in million VND

The model can be presented as:

Dependent variable = f (HC, CE, LC), where:

* Dependent variable is PHA in logistic model:

PHA = 1 if household can access to formal credit sector)

- PHA = 0 if otherwise

* Dependent variable is LA in the OLS model to examine household's bank loan amount:

- HC: vector of householder characteristics

CE: vector of household' characteristics endowments

LC: vector of loan characteristics

The independent variables include sets of variables:

a The vector of householder characteristics includes age (AGE), gender (SEX), education (HHEDU) In Vietnam, the head of household plays an important role in decision-making related to family as well as community So, the characteristics of householder are used in the model to examine the hypothesis that the effect of them

on household access to formal credit

b The vector of household' characteristics endowments affecting credit demand includes household size or the number of household members (HHSIZE); work for salary/wage (EMPWAGE); do production or service planting breeding, forestry or aquaculture (EMPSELF AG); do trading or business (EMPSELFNAG); real expenditure per capita of rural poor, called PCEXP2RL; the value of house

(HOUSEV ALUE); owning living house or not (HOUSEOWN2); the farm size of household owned (F ARMSIZE); and finally is poor household or not (POORHOUSEHOLD)

c The vector of loan characteristics: As mentioned above, aim of borrowing and uses of loan, the limited of the funds, high transaction costs, etc, are factors that can affect to access to formal credit sector That is reason for introducing the vector of loan characteristics, including purpose of loan (loan used for what - called

(PERCENTINTERESTRA TE)

Data extraction

Data used in this thesis has been draw from VHLSS 2006 (Vietnam Household Living Standard Survey 2006) and from VHLSS 2008 in the rural area of Mekong River Delta This thesis focuses on rural households that have demand for credit but could not borrow or borrow a limited credit from the formal credit sector; then suggest the policy implication to help the households get or easier access to credit from the formal sector The total observation of the survey in the rural areas of Mekong River Delta is 885 observations with VHLSS 2006 With VHLSS 2008, this number is 856 observations The extracted data will be used for descriptive and econometric regression analysis

Here is the summary of the independent variables (signatures, explanations, where

to extract them from the VHLSS and their expected signs)

Table 3.1: Table of independent variables

Name of independent Explanation Unit Where to extract Expected

Household is poor or not

Item 8, question

I poorhousehold =I: ifpoor

=0: otherwise Household uses loan for what

= 1: if loan used for Production

2 purposeofloan capital, Capital investment, Item 8, question ambiguous

= 0: if loan used for consumption and others

3 percentinterestrate The interest rate of the loan percenta ge Item 8, question number 15a

-4 housevalue Value of living house 1,000 Item 7, question ambiguous

Work for wage/salary

Item 4A, question

8 empwage =1: work for wage/salary

=0: don't work Household production or service planting breeding, forestry or

number2

=0: if female 12.age Age of household head years old Item 1A, question ambiguous

number 5 The number of year that Item 2, question

13 hhedu household head attend in school years

The household head owns living

14 houseown = 1: if owning (partially or fully) number6 +

=0: otherwise

CHAPTER 4: FINANCIAL SYSTEM AND ACCESS TO FORMAL CREDIT

BY HOUSEHOLDS IN THE MEKONG RIVER DELTA

4.1 Rural financial system in Vietnam

4.1.1 Overview of rural financial supplier

All activities of the rural financial market are under control of the government and State bank of Vietnam regulations and policies Similar to other developing countries, the Vietnam rural financial market is regarded as a repressed market, which is segmented mainly in such aspects: aim of borrowing, conditions of loan, amount of loan, terms and maturity of loans It also has the formal and informal credit sectors working in parallel (Nguyen Huu Cuong, 2007)

In this market, the formal credit sector does not prefer to provide credit for consumption, so the households have to borrow from the informal sources such as relative, friends, and neighbors If the households are rated as not good borrowers, they have to seek credit from moneylenders, especially in case of emergency such

as illness, funeral, wedding, etc

Because the total borrowing cost of the informal source is smaller than the cost of borrowing from the formal credit sector, which is characterized by high transaction cost and low interest rate, the households are more likely to borrow from the informal sources for small loans or even for production purposes

The credit market can be divided into three sectors: formal, semi-formal and informal credit sector

a The formal credit sector: includes the government's commercial banks, private banks and other organized credit institutions The activities of these institutions are regulated by the law on Credit Organizations Formal credit sector has been criticized for not satisfying the needs of the poor communes timely

The Vietnam Bank for Agriculture and Rural Development (VBARD)

Established in 1988, VBARD is not only the largest commercial bank in the country but also the major financial provider in rural areas, with branches in every provinces

of Vietnam

Methodology: three different credit methodologies:

First, VBARD decides to provide credit to borrowers based on the requirement about collateral such as LUCs

Second, VBARD lends to an individual in a group with conditions that all of the other people in the group must take the responsibility on repaying the loan if that individual cannot refund fully A new loan can only be lent if this group has no debt This methodology increases VBARD's coverage of households in the rural area, reduces transaction costs associated with making and collecting many small loans

Third, VBARD lends guarantee groups through mass organizations such as Vietnamese Women Union, which targets borrowers unable to provide collateral

Clients

According to the report of VBARD, to the end of the year 2011, the total outstanding loans was 443.47 thousand billion dong, in which, the credit for agriculture and rural area was more than 301 thousand billion dong, accounted for 68% the total credit

Innovations

By using mobile banking units, VBARD officials go to remote communes to seek borrowers, process their applications, disburse money and collect repayments, mobilize savings

The Vietnam Bank for Social Policies VBSP