Determinants of accessibility to microcredit in term of formal sector and informal sector

This dissertation attempts to investigate the determinants affecting the probability of participation in different types of credit sectors in terms of formal sector and informal sector..

UNIVERSITY OF ECONOMICS, HO CHI MINH CITY

VIET NAM – NETHERLANDS PROGRAMME FOR M.A PROGRAM IN

DEVELOPMENT ECONOMICS

DETERMINANTS OF ACCESSIBILITY TO

MICROCREDIT IN TERMS OF FORMAL SECTOR AND INFORMAL SECTOR

Microcredit is an emerging concept helping the poor out of poverty situation This dissertation attempts to investigate the determinants affecting the probability of participation in different types of credit sectors in terms of formal sector and informal sector Using a sample size of 1,522 households participate in credit market from The Vietnam Access to Resources Household Survey (VARHS) 2012, bivariate probit model is employed to explore the determinants of household credit demand due to the binary nature of the dependent variables Various explanatory variables include age, gender, marital_stt, edu, hhsize, income, savingamount, landsize, agriculture_act, network and location that influence probability of accessibility to different sectors of credit Furthermore, relationship between dependent variables is accounted in this research Results reveal that factors affecting formal credit participation are different from factors affecting informal credit participation Additionally, the result indicates that there is negative correlation across two sectors of credit

ACKNOWLEDGEMENT

I would like to express my deepest thankfulness to my advisor, Dr Cao Hao Thi who spent lots of his precious time to support and guide me throughout this research and continuously led me to the right way

I would also like to extend my appreciation to the teachers working on Vietnam Netherlands programme who gave great lectures and invaluable knowledge for us

to complete the course

I am grateful to my parents and my siblings that always encourage and support me

in my study and in every aspect of life

I also want to express my gratitude to my friends for sharing with me the difficulties and giving me the ideas, knowledge and materials for the study and for all the time we were at Master in Development Economics 19

LIST OF FIGURES

Figure 2.1 Probability of success and expected returns to borrowers 9

Figure 2.2 Return to the bank 11

Figure 3.1 Microfinance Systems in Vietnam 22

Figure 4.1 Process of research 30

Figure 4.2 Participation in credit sector 33

LIST OF TABLES Table 2.1 Definition of Variables 18

Table 3.1 Microfinance Institutions in Vietnam 20

Table 3.2 Comparison between formal and informal lenders 28

Table 4.1 Summary of Participation in different credit sectors 32

Table 4.2 Conditional and Unconditional Credit Participation Probabilities 33

Table 4.3 Summary statistics 34

Table 5.1 Determinants of accessibility to formal and informal credit sector 38

Table 5.2 Marginal effects for conditional probability of formal sector participation 44

Table 5.3 Marginal effects for conditional probability of informal sector participation 46

TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION 1

1.1 Problem statement 1

1.2 Research objective 3

1.3 Research questions 4

1.4 Research Structure 4

CHAPTER 2: LITERATURE REVIEW 5

2.1 Concept of credit 5

2.2 Theory of demand for credit 6

2.3 Credit rationing theory 7

2.4 Determinants of participation in microcredit programs 11

CHAPTER 3: OVERVIEW OF MICROFINANCE SYSTEM 19

3 1 The history of Microfinance 19

3.2 The role of government in microfinance: 21

3.3 Overview of credit market in Vietnam 22

3.3.1 The formal credit market 23

3.3.2 The semi-formal credit market: 26

3.3.3 The informal credit market 26

CHAPTER 4: RESEARCH METHODOLOGY 30

4.1 Research process 30

4.2 The data 31

4.3 Data Analysis Method 35

CHAPTER 5: RESULTS AND DISCUSSION 38

5.1 Estimation of determinants of microcredit participation 38

5.2 Estimation of conditional marginal effects 44

CHAPTER 6: CONCLUSION 48

6.1 Research Findings 48

6.2 Policy implications 49

6.3 Limitations 50

REFERENCES 52

CHAPTER 1: INTRODUCTION 1.1 Problem statement

There are about 1.22 billion people (21 percent of population) in the world living on less than $1.25 a day in 2010 (World Bank) Focusing towards poverty reduction and finding ways to improve living condition have taken a lot of attention of public policies in the world The rate of poverty in Vietnam decreases remarkably in recent years According to annual report shown by GSO, the poverty rate declined from 15.5 percent in 2006, to 13.4 percent in 2008, to 10.7 percent in 2010 In a report of GSO in 2010, it also revealed that poverty level in rural area (13.2 percent) is much higher compared to that in urban area (5.1 percent) How to distribute the benefits

of economics growth, especially to rural area is one of the challenges remained Therefore, rural economy deserves more attention and support to reduce inequality between rural and urban area

According to McCarty (2001) and Pham & Lensink (2002), lack of ability to obtain the fund for the purpose of working capital and investment is one of the reasons among other things that lead to poverty in developing countries Providing a channel to ease the credit constraints for the poor rural household is the primary object in poverty alleviation strategy of developing countries, including Vietnam Farmers need an instrument such as credit to enhance productivity and promote standard of standard of living because of their seasonal activities and uncertainty they are facing (Ololade & Ologunju, 2013) Accessing to microcredit is recognized

as a potentially effective tool out of under poverty line situation and improve living standards (ADB, 2000a; Morduch and Haley, 2002; Khandker, 2003) Agricultural credit plays an important role in sustainable achievement in any country in the world Microfinance industry has been known in many decades in developing countries, and its role was further attended with rapid growth worldwide when Mohammad Yunus who pioneered the principle of microfinance and microcredit

received Nobel Peace prize in 2006 (Tra Pham and Robert Lensink, 2007) And a variety of previous researches demonstrated the position of microfinance in poverty reduction by focusing on the effect on household welfare The demand for rural credit has increased sharply due to the decollectivization of agriculture launched in Vietnam in the year 1986 Hence, the spread of microfinance with amendment of regulations on banking operation in Vietnam plays an important component in fighting again poverty over the last decades Vietnam has introduced several of microcredit programs via a lot of channels such as banks, credit funds, money lenders and advance input providers to supply credit for a variety of clients

Despite the importance of credit to the poor, the poor family that lacks ability to access to adequate financial service leads to the fact that they do not have prospects for increasing their productivity and living standard And the fact that commercial banks have no interest in allocating credit to the poor because of their lack of viable collateral Because of these reasons, governments in developing countries have set

up credit programs that aim at improving the process of rural household access to formal credit during the past four decades (Diagne, 1999) However, the lending mechanisms as well as the nature of the credit market which are highly regulated by government intervention such as controls of interest rates and credit quota allocation

do not function well

Similarly, Robinson (2001) and Gonzalez Vega (2003) also indicated that most of microfinance institutions have been not sustainable in developing countries Credit subsidized interest rate provided by “Agricultural development banks” which established by commercial banks to extend credit to rural household not considered creditworthy However, majority of these credit programs have failed to reach their targets both to be sustainable credit providers and serve the poor (Adams, Graham, and von Pischke 1984; Adams and Vogel 1986; Braverman and Guasch 1986) Risk management and transaction costs associated with Asymmetric information are the most problematic features facing by lenders and borrowers (Pham & Lensinnk,

2007) It is also well know that different forms of credit market serve different group of borrowers, it is difficult for large number of poor households to access to credit sources Households often face limited access to credit because of rationing

of credit demand that leads to the poor and low income households are generally excluded from the formal credit sector (Stiglitz & Weiss, 1981) In fact that formal provider, semi-formal provider and informal provider exist side by side

in Vietnamese financial market To deal the level of information asymmetry between borrowers and different lenders, many government microcredit programs are accompanied by the local Peoples Committees in terms of lending process to assist microcredit market operation

In respect of this, narrowing gaps in term of whom it serves and the service it provides, improving the efficiency and effectiveness of microfinance system is the main challenge of policy makers as well as program organizers

With data collected from The Vietnam Access to Resources Household Survey

2012 (VARHS) which supplements and extends the VHLSS (Vietnam household Living Standards Survey) by repeating surveys of the same household with data from VHLSS and asking more questions about income, expenses, land, agriculture, asset, investment, migration, climate change, social welfare and so on; VARHS received assistance from University of Copenhagen, CIEM, ILSSA (Institute For Labor Science and Social Affair), and IPSARD (Institute of Policy and Strategy for Agricultural and Rural Development), econometrics techniques are employed in this research to explore the factors that affect access to credit in terms of formal credit and informal credit

1.2 Research objective

The objective of this thesis is to empirically investigate the determinants that influence on the probability of household accessing to different types of credit

sectors as well as the relationship between formal credit participation and informal credit participation at the same time

Additionally, marginal effects of each independent variable on the choice of credit source are also shown in this research

1.3 Research questions

This research is to answer two central questions:

What are determinants affecting the probability of household accessing to different types of credit sector?

Is there any evidence of a correlation between participating in formal credit and participating in informal credit at the same time?

1.4 Research Structure

This dissertation is organized as follows In chapter one, problem statement and objectives of this research are presented Chapter two provides concepts related to this research, discusses theory for demand credit and credit rationing theory and introduces explanatory variables Chapter three presents the history of microfinance

as well as the role of government in microfinance It also provides insight into the structure of credit market in Vietnam Chapter four presents research structure, data description and methodology method used in this research Chapter five gives empirical models and the estimated results Finally, conclusion, policy suggestions and limitations are highlighted in chapter six

CHAPTER 2: LITERATURE REVIEW

This chapter presents the overview of theory and discusses previous studies relate to the research topic The first part mentions about microcredit regarding concept of credit The second part discusses about theory for demand credit and credit rationing theory The last part discusses about the determinants affecting credit accessibility

Ololade & Ologunju (2013) defined credit as a mean for temporary transfer of assets to individuals or organizations that has not them from individuals or organizations that has This process required evidences of debt obligation in return for a loan, in the case of transaction between friends or relative which based on good relationship excluded

Microcredit which is a component of microfinance provides small loan to the poor for self –employment That generates income, helping them care for themselves and their family (The Microcredit Summit, 1997)

To raise income level and improve living standard of semi-urban and urban areas are considered as targets of microcredit by providing of thrift, credit, other financial services and products of every small amount to the rural household (Reserve Bank

of India- Master Circular, 2011)

The definition of Microfinance differs from person to person, but microfinance can

be defined as small assistance to low-income individuals (CGAP) These assistances come in variety of forms including savings, money transfers, payments, remittances, and insurance, from others to low-income people (Christen R.P., 1997) All services aim at primarily focus on reducing poverty (Khan & Rahama, 2007)

Microfinance is also defined as a development approach, which is composed of financial and social intermediation to benefit for the poor (Legerwood, 1999) Microfinance institutions (MFIs) provide not only credit but also services such as group formation, development of self-confidence, and training in financial literacy and management capabilities among members of a group

Microcredit is widely used interchangeably as microfinance but microcredit, as a part of microfinance, is a provision of loans to the poor Microfinance, on the other hand, has broader category of services such as loans, saving and insurance

2.2 Theory of demand for credit

According to life circle model (Franco Modigliani, 1966), individuals cannot maintain consumption at an acceptable level when the size of family changed with uncertainties of future To maximize time life utility, income should be reallocated inter-temporally (Morduch, 1995a) Consumers can afford their purchases by using saving from past or present income or by accessing to credit funds which help borrowers to make inter-temporal choice By borrowing money, borrowers have additional spending power in the present and duty to pay loan and interest rate in the future in exchange (Soman & cheema, 2002)

The inter-temporal model of life circle hypothesis and permanent hypothesis which explain the consumption behavior of individuals were also discussed by Modigliani in1986 It is assumed that borrower have opportunity to borrow in perfect market in Modigliani’s model

In model of Chen and Chiivakul (2008), current household‘s consumption level not only depends on the current income but also depends on household’s life time characteristics (behaviors of household on participation in credit market) Additionally, it is argued that current consumption depends on expected consumption in the future period (consumers firstly estimate their ability to afford consumption in long run) which depends on their saving or demand for loan (Hall, 1978)

Moreover, in Cobb Douglas function: Y = ALαKβ, capital is viewed as a production input factor, accessible and affordable inputs; profit from production depends on labor (L) and capital (K) with given technology (Zellne at al., 1966) Cobb Douglas showed how two factors (Capital and Labor) effect on production function and how income distribution is effected by production output (Felipe and Adams, 2005) This capital can be provided by a variety of credit sources at different interest rates (cost

of capital)

2.3 Credit rationing theory

In 1981, Stiglitz and Weiss based on two assumptions to introduce theory of credit rationing:

(1) There is unable to differentiate level of risk associated with safe and risky borrower, and

(2) Loans are subjects to the ability of repayment ability of borrower at the end of investment period

There are two types of problem including adverse selection and moral hazard in microcredit market due to the presence of asymmetric information The former relates to the screening process where transaction costs (interest rate) is various between good and bad borrowers while the latter arises in the monitoring and enforcement mechanism where the borrowers do not make every effort to repay for

lenders because they know the risk is shared by lenders ( Pham & Lensink, 2007)

In general, lenders judge borrower’s creditworthiness basing on a set of information that they have

The model of Stiglitz and Weiss (1981) assumes that expected return of projects (Ei)

is identical but the probability of success (𝑝i) is different Eis and Eif present for return of project in the case of success and failure respectively The bank offers loan (B) to every borrower with the same rate (r)

In the case of success, the return of project is greater than the money that borrowers must pay for bank, (1+r)*B, while the return in the case of failure is lower than the repayment giving to lender The project is feasible if expected return is higher than the opportunity cost (Ci) (Stiglitz & Weiss, 1981) Expected return of project as follows:

The first derivative of the function is lower than zero, so expected return function is

a decreasing one It implies that expected return of project decreases when the probability of success increases

From equation (2.2), using the implicit function theorem to differentiate r respects

Figure 2.1 Probability of success and expected returns to borrowers

Figure 2.1 illustrates the effect of interest rate and opportunity cost on expected returns to the borrowers E1 is expected returns to a marginal borrower at 𝑝im which

is the probability of success of marginal borrowers As shown before, an increase in interest rate (r) leads to a decrease in expected return to the borrower from E1 to E2

which is lower than the opportunity cost Hence, marginal borrowers drop out of the market E3 is expected return of new marginal borrower, with the probability of success is 𝑝im’which is lower than the previous pim

According to Quach (2005), there is the same effect of opportunity cost on expected return

From the perspective of the bank, the expected return is:

Differentiating function (2.6) with respects to pi:

𝜕𝜅(𝑝𝑖,𝑟)

𝜕𝑝𝑖 = (1+r)B - Eif (2.7)

The first derivative of the function is greater than zero It implies that an increase in probability leads to an increase in expected return to the bank

If the interest rate increases:

(1) The value of component (1+r)*B increase

(2) The value of pi decrease (according to function 2.5 shown above), which leads to lower expected return as result of withdraw of lower-risk borrowers (Stiglitz & Weiss, 1981)

Stiglitz and Weiss (1982) mentioned about critical equilibrium interest rate; at that,

if the current interest rate is lower than critical equilibrium interest rate, interest rate

of the bank can be increased without any significant withdraw of borrowers and income of the bank is higher If the interest rate increases over critical equilibrium interest rate, lower risk borrowers will drop out credit market that leads to a decrease of lender’s profit In this case, credit is allocated at critical equilibrium interest rate by bank

Figure 2.2 demonstrates relationship between returns to the lenders and interest rate (r) At critical equilibrium interest rate rra where the supply of fund meets the demand for fund, expected return of the bank is maximized without rationing

Figure 2.2 Return to the bank 2.4 Determinants of participation in microcredit programs

When income and wealth to increase purchase are insufficient, households borrow money as a way to finance their consumption (Kirchler et al., 2008) There are two stages in process of getting loan First, the households who demand credit apply for

a certain amount of loan for a type of credit sector which they want to borrow from Second, the providers choose which applicants are met requirements for loan based

on household’s information and availabilities of the lenders

Stiglitz and Weiss (1981) showed that behavior of accessibility to credit is explained by demand theory (demand side) and rationing process of credit (supply side)

Vaessen (2002) pointed out that accessibility to credit in Northern Nicaragua was resulted in the interaction between demand side (characteristics of household) and supply side (characteristics of financial institutions) Duong Pham (2002) also

rra

E

r

focused on characteristics of both demand side and supply side in determining factor that influence on accessibility of rural credit in Vietnam

However, in this analysis, I focus on demand side’s characteristics to consider the probability of access to credit The determinants of microcredit participation include age, gender, marital_stt, edu, hhsize, income, savingamount, landsize, agriculture_act, network and location

2.4.1 Age

According to the life circle hypothesis, the age is negative relationship with the decision to get loan It is also confirmed in research of M Ajugam and C Ramasamy (2007) Similarly, Okurut (2006) and Mohamed (2003) pointed out that the possibility to access to credit resources decrease when they get older Younger persons more likely to borrow than the elderly because of elements of personal risk level (Fabbri and Padula, 2004; Zeller, 1994; Magri, 2002; Abdul- Muhmin, 2008; Del- Rio and Young, 2005); additionally, the young tend to spend more on a variety

of activities while the old maybe less (Mpuga, 2008)

In contrast, some studies showed accessibility to credit positively related to age For example, Tinh (2010) demonstrated that age of household head has a significant positive relationship with getting a loan It was also proven in research in 2010 of Tang et al

2.4.2 Gender of household’s head

Banerjee et al (2010) Bruno and Cre1pon et al (2011) prove that there are a majority proportion of male borrowers from the microcredit programmes Moreover, Nwaru (2011) and Bendig et al (2009) also proven that demanding in loan negatively related with being female

However, contrary to mentioned studies, Owuor George (2009) stated that being a female headed household increases probability of joining financial activities

2.4.3 Marital status

A vast of previous studies showed that married individuals are likely to get loans than unmarried individuals because of the level of needs (Kamleitneir and Kirchler, 2007; Bridges et al., 2004; Chen and Jensen, 1985; Duca and Rosenthal, 1994; Magri, 2002) Similarly, in a research by Kenya National Fin Access (2009) indicated that the probability of credit program participation is the highest with married persons It is explained that there is difficult to access to credit for single household due to lack of social network (Ferede, 2012)

2.4.4 Leve l of household head’s education

Education was an important factor that influences the probability of accessibility of microcredit programmes (Tang et al., 2010) Quach (2005) demonstrated that education level had a positive relationship with demanding in loan Moreover, education level was founded as a determinant that fosters the accessibility to microcredit programme thanks to their awareness of financial market system (Yehuala, 2008; Okunade; 2007; Vaessen, 2001; and Okunade, 2007)

On the other hand, Khandker (2001) and Khandker (2005) demonstrated that higher education level of household head would less likely to borrow from microcredit program Similar to Khandker’s finding, Cuong H Nguyen’s research (2007) also proves that household head with higher education has lower chance of accessibility

to credit sector in Vietnam which composed of high proportion of borrowers with education level at primary and lower secondary school

It is interesting that the impact of this variable on various source of credits are different Bendig et al (2009) stated that better educated individuala tend to access

to formal financial sector Moreover, there was an inverse relationship between education and informal loan

In contrast, Bendig at al (2009) argued that household size has negative impact on probability to credit in a research of demand for financial service This is due to the assumption that there are more dependent members including children and elderly people who would consume a large share of income in their family and had higher risk of default (Tang et al., 2010)

However, household size did not effect on getting loan in Greece (Mitrakos and Simiyiannis, 2009)

2.4.6 Household’s income

Income is the most common measurement used to define the poor (The World Bank); hence, household with high income is not considered as the poor whereas the primary target of microcredit is to provide credit to the poor who will provided credit to increase income (World Bank, 2010) Therefore, applicants with higher income have lower chance to get loan This idea was proven in the research by Pham & Lensink (2007) and Li et al (2011) that household’s income negative correlation with probability of participation in credit program including microcredit

It is also explained that marginal utility of consumption of poor household is high, leading to more demand for credit of the poor (Ferede, 2012)

In contrast, many researches argued that high-income household more likely access

to loan than low-income household (Crrok, 2001; Lin and Yang, 2005; Jappelli and Pistaferri, 2007) The reason for that is due to assumption that high-income households hold mortgage (Ambrose et al., 2004)

2.4.7 Saving amount

Saving amount is identified as collateral to reduce adverse selection and moral hazard arising from lending process between lenders and borrowers Compared to others, saving amount is more liquidity Therefore, applicants with bigger saving amount have more opportunities for accessing credit sector It means that relationship between household saving and possibility to lend credit is positive However, total saving is considered as a determinant of household’s demand for credit; hence, saving amount is negatively related to probability to approach credit sector (Tang et al., 2010) It is explained that households with larger saving amount tend to borrow less because they have money for affording their spending at acceptant level, they are non-poor

In contrast, finding by Okurut (2006) revealed that land endowment has a positive correlation with household’s probability to borrow credit Land title may be considered as collateral for household’s borrowing, so it is easier for household with bigger land size to get loan from formal sector (Sai et al, 2010) This result is in the line with the finding by Vu (2002) and Zeller (2001) that Land is the most important variable to measure the household’s ability to get credit, especially credit from formal sector Additionally, some empirical research states that households with large own land scale which is the basic source of livelihood of the farmer demands for more credit in order to run production activities (Mohamed, 2003; Ravi, 2003 and Davis et al., 1998; Svay et al, 2006)

2.4.9 Social network

Relationship between probability of accessibility to credit and social capital has been a controversial issue A vast of literature has revealed that social capital play a crucial role in credit accessibility, particularly in developing countries (Okten and Osili, 2004; Fafchamps, 2000) Social network is considered as social collateral in order to obtain credit and there is a strong positive relationship between social collateral and credit borrowing shown (Karlan et al, 2009) Bui (2010) also indicated that social capital also play an important factor on credit ration This result

is consistent with the finding by Grootaert (1999) that social capital has positively influence for accessing to credit Additionally, borrowers rely on social network to lower uncertain information lead to a better flow of information between lenders and borrowers, so demand for credit increase (Thierry, 2000) Considering the role

of social network on credit obtaining, it is expected that social capital is a determinant of credit transaction

Different from previous result, some indicates that social network does not guarantee poor households participate in rural credit (World Bank, 2000)

The objective of this research is to find out the effect of social network not only on overall credit but also on types of credit, informal sector and formal sector

2.4.10 Location

The main objective of rural credit is to help the rural poor household out of poverty situation, so it is assumed that households in rural area have higher probability to get credit compared to that located in urban area

However, Consultative Grove to Assist the Poor (CGAP) demonstrated that the probability of accessibility to credit source in rural area is probably significant lower than in urban area Microfinance for rural areas is not sustainably provide financial services for rural populations; only densely populated areas benefit from a widespread microfinance services Therefore, households in remote area have less chance to access to credit services This might be due to opportunity costs of time spending, transaction costs to travel to financial institutions and deficiencies in communication with lenders because of long distance (Zeller & Sharma, 2000) This negative relationship between location and demand for credit supported the result of research by Balogun and Yusuf (2011)

In this research, I examine how location variable does affect the possibility to approach credit source of household

2.4.11 Rural activities

One target of microcredit is to help the poor on rural farming activities Therefore, it

is assumed that households have more probability of accessibility to rural credit if the households take part in rural activities

All variables in this econometrics research are defined in the Table 2.1

Table 2.1 Definition of Variables

Variables Type Explanation

Age Continuous Age measures the age of household’ head and it is

performed over 18 years old Gender Binary

Gender is sex of household head This is dummy variable which takes a value one if the household head is female and zero if the household head is male

marital_stt Binary

Marital status is divided into two categories including married if the household head is married and single otherwise Marital status would be coded as 1 for married, and 0 for single

Edu Continuous

Edu is education level of household head This variable is measured by number of schooling year of household head attending

Hhsize Continuous Household size is considered as the number of member in

family

Income Continuous Income is the total income of household (1,000,000

VND)

Savingamount Continuous It is measured in 1,000,000 VND

Landsize Continuous Landsize is is the size of land owning by household It is

Location Binary 1- household is located in rural area

0- other wise

CHAPTER 3: OVERVIEW OF MICROFINANCE SYSTEM

The first part of this chapter presents the history of Microfinance The second part discusses the role of government in Microfinance In the last part, the overview of Vietnamese microfinance system is mentioned

3 1 The history of Microfinance

According to Robinson (2001) and Otero (1999), microcredit and microfinance are relatively new terms in the field of development, first coming to become prominence in the 1970s Since 1980, financial institutions such as Grameen Bank and Bank Raykat Indonesia started to offer loans to the poor and organizations without subsidies or funding from governments Since then, the term microcredit has become quite popular

There are an increasing number of microfinance institutions coming into operation

in the 1900s In addition, microfinance services have grown out to various kinds of forms such as savings, pensions and so on

The first microcredit Summit was organized in 1997 proving the importance of microfinance to the development of the world During the summit, the board has agreed to put the plan to assist 175 million poorest families around the world

Vietnam currently has a variety of Microfinance Institutions offering loans and others services to a number of poor households Table 3.1 presents loan portfolio (in VND) and number of active borrowers provided by Vietnamese Microfinance Institution in the recent years 2012 and 2013

Table 3.1 Microfinance Institutions in Vietnam

Number of borrowers

Ha Tinh Women Development

Small Credit Fund For Housing

Soc Trang Fund for Poor Women 221,374 #N/A 3,184 #N/A

Women Development Fund, Lao

3.2 The role of government in microfinance

Although the impact of the state on the microfinance sector brings different results, even negative effects such as limiting the distribution of services the private sector, but in general, it is recognized that the state plays an important role in the development of the microfinance sector In specifically, the role of the state is divided into three categories: protector role, provider and promotional role

One of the three roles, the protector role is the most important role, because it creates confidence for households with low income or poor people in general, it also indicates an imbalance between local recipients of credit and credit institutions The main tool of this role that the state uses is the legal environment State has enacted regulatory environment aimed at protecting savers, as well as providing accreditation for credit institution in order to combat unfair competition To improve the efficiency of environmental legal, the state must provide it in a flexible way, and not rigid

With provider role, government participates as direct provider of microfinance services to the poor people However, with the direction involvement like this, this can create unfair competition for credit institutions, such as the provision of preferential credit over financial institutions Therefore, with this role, the state should support the credit institutions and join in the provision of payment services

or save instead of providing preferential credit

State in promotional role implemented through indirect and direct Policies and investments are considered as indirect promotional tool, this type is to create benefits for the microfinance industry, but does not focus on promoting fair competition, as well as enhance a strong payment system In the meantime, with direct channel, state does through the development of microfinance strategy establishes the wholesale organization, provides financial and technical assistance to un-served areas

3.3 Overview of credit market in Vietnam

Like other countries, credit system of Vietnam comes from three main sectors including formal, semi-formal and informal sector (Meyer and Nagarajan, 1992) The coexistence of formal sector, informal sector and semi-formal financial sector not only provide greater credit source for the poor but also create greater competition among different credit suppliers in rural credit market There are different in term of interest rate and lending practices between formal sector, semi-formal sector and informal sector (Pham and Lensink, 2007)

Figure 3.1 Microfinance Systems in Vietnam

The Vietnam Bank for Social Policies

Vietnam Bank for Agriculture and Rural Development ((VBARD)

The People’s Credit Funds (PCF)

NGOs and others

Relatives, Friends and Neighbors

Private money lenders

Rotating Savings Credit Associations

Formal sector

Semi-formal sector

3.3.1 The formal credit market

According to World Bank (2002), the formal sector is composed of Vietnam Bank for Social Policy (VBSP), Vietnam Bank for Agriculture and Rural Development (VBARD) which are state owned organizations, and the People Credit Funds (PCF)

It was also reported by World Bank (2002) that lending by formal sector is accounted for 73.5% of total lending Formal sector aims at covering the overall rural credit market The main strength of this form is that it has a wide network with good connection to Local People Committee which plays an important role in financial system of Vietnam However, its operation falls in short of achieving the defined objectives (Phan, 2012)

a The Vietnam Bank for Social Policies (VBSP)

The Vietnam Bank for the Poor (VBP) was organized in 1995, and it was official renamed to The Vietnam Bank for Social Policies (VBSP) under Premier’s Decision No.131/2002QD-TTg date October 4th, 2002 and the government’s Decree No 78/NP-CP dated October 4th, 2002 for the poor VBSP in the second largest state-owned Vietnam bank established is for the poor and other policy beneficiaries It operates as an efficient tool helping Vietnam government to fight against poverty by providing low interest rate with formal collateral and accessible financial services to the poor households to reduce the gap that has emerged and to alleviate poverty (Izumida, 2003) VBSP functions under State Bank of Vietnam’s supervision and granted by Vietnamese Government In theory, serving the low income households

to obtain credit is the target of VBSP; but in practice, it failed to provide service to the poor In 2001, only half of VBSP clients served was listed as poor households The most quickly method is applied to delivery loans to the poor via four mass organizations namely: War veteran Union of Vietnam, Framer Union of Vietnam, Youth Union of Vietnam and Women of Vietnam Their responsibilities are

establishing saving and credit group; certifying poor households and supervising borrowers in using loans properly

As of July 2003, six programmes are offered loan by VBSP:

(1) Loan to low-income households

(2) Loan to disadvantage student

(3) Loan for job generation promotion (Resolution No.120/HDBT, dated

April 11,1992)

(4) Loan for foreign migrant worker

(5) Loan for difficult development areas

(6) Loan for policy beneficiaries

The outstanding loan of VBPS reached the amount of 72,660 billion VND with 7.5 million borrowers were provided (VBSP, 2009)

b The Vietnam Bank for Agriculture and Rural Development (VBARD)

The Vietnam Bank for Agriculture and Rural Development (VBARD) which is known as the Vietnam Bank for Agriculture was established in the year 1988 VBARD is the state policy bank and the leading channel proving credit to rural households in all types of agriculture activity in rural areas (BWTP, 2008) Collateral such as residential property, movable assets, goods or land rights are required in lending process of VBARD Both rural households and the LIHs are clients of VBARD According to Wolf (1999), the share of rural household accessing to VBARD increased significantly to 30% in 1994 from 9% in 1992.VBARD had become the largest commercial bank by the end of the year 2001 with more than 2,300 branches nationwide serving 50% of the poor that access to financial services (BWTP, 2003)

However, VBARD prefers to provide credit to state-owned enterprises (SOEs) which are considered zero risk clients thanks to government’s supporting AlthoughVBARD has been the major source of credit in rural area, its lending coverage is still failed to serve entire rural credit market, particularly to the poor households Bias in risk assessment of complicated lending process is the main reason of undeveloped VBARD’s operation

There are three functions of VBARD:

(1) To provide credit to rural farmers and entrepreneurs with collateral

(2) To reduce transaction costs as well as increase its coverage of rural households, group lending methodology is used

(3) To provides opportunities for borrower who are unable provide collateral, brokerage services of mass organizations are used by VBARD Under this system, loans are guaranteed for repayment to VBARD by members of organization

c The People’s Credit Funds (PCF)

After the collapse of Vietnam’s rural credit cooperatives in the late 1980s, Government established People’s Credit Funds (PCFs) as a part of a state policy to support and reform the banking system of the country To restore public’s confidence in the formal rural credit system is the most important objective of PCFs establishment (Putzeys, 2002) An organization of self-help, self-organization and self-management were modeled by People’s Credit Funds Farmers and small entrepreneurial households are targeted clients of PCFs (Putzeys, 2002)

There were more than 900 individuals PCFs available in 53 provinces by the end of the year 2004 (BWTP) However, their network was located in economically better off and better developed infrastructure areas; so, PCF’s coverage is limited in poor region

3.3.2 The semi-formal credit market

Semi-formal credit sector contains Women’s Union, Farmer’s Association, Youth Union….or non-governmental organizations (NGOs) financial program are funded

by international and national donor (Phan, 2012) Although semi-formal credit funds do not have nationwide network, they have a variety advantages as compared with formal lenders that serve the poor as targeted customers by providing subsidized credit Additionally, semi-formal such as NGOs are recognized as the best channel providing credit, especially in group lending and social intermediation

to help the poor thanks to experiences taken from abroad (Dao,2002; McCarty,2001) Moreover, semi-formal sector is considered as an important channel of many international programs for combat poverty (World Bank, 2000, p.110)

3.3.3 The informal credit market

Informal financial system consists of relatives, friends, neighbor, unregistered private money lenders, traders and rotating savings and credit associations (ROSCAs) (Quach, 2005)

a Relatives, Friends and Neighbors

This kind of credit is normally free in term of interest rate with different terms of loan (monthly, quarterly, half yearly or yearly) which depend on the availability of extra income and the relationship between borrowers and lenders Relatives, Friends and Neighbors provide credit without collateral or written loan contract by taking advantage of personal relationship However, this source of credit is to help Friends, relatives, neighbors in case of emergency, consumption for illness, funerals, wedding and so on rather than to finance agricultural production (Pham & Izumida, 2002)

b Private Money Lenders

There are a range of terms (permanent, seasonal, daily) in credit is provided by private money lender They are usually the rich in rural areas and have a lot of money for lending (Quach, 2005) However, the data on the number of money lenders and number of using credit from money lenders is not estimated because this transaction is informal between borrowers and lenders According to Dao (2002), money lenders provide credit and negotiate for a rate about 3-10% per month

c Rotating Savings Credit Associations (ROSCAs)

Rotating Savings Credit Associations (ROSCAs) which are known as an informal credit channel for rural household in Vietnam base on an individual’s social connection existed for providing credit to many generations However, ROSCAs are not regulated under the Law of credit due to weak social sanctions and weak screening process (Phan, 2012) There associations are referred as “Hui” which originates from the South of Vietnam and “Ho” which originates in the North of Vietnam (Pham and Lensink, 2007) Members of these groups come from the same career such as group of farmer, groups of traders, groups of war veterans or come from the same hamlet

Two main forms of ROSCAs are applied to rotate the fund to participants:

(1) Using of random allocation; in this process, each member put a fix amount of money periodically Total money in the pot is allocated for one of the members randomly In the next period, the circle is repeated with every previous winners excluded This circle of ROSCAs ends when all participants of group collecting the fund at least one time

(2) Using of bidding process In bidding ROSCAs, participants are contacted by organizer at the beginning of each round In order to early receive the pot, bidding

participant forgoes a bid amount of money Winner of rotation is the person who is willing to submit the highest bid Others who have not yet received the pot contribute amount that equal to fix amount discount the bid amount Winners in previous rotation continue to pay original amount in subsequent round

There are a vast of literature on lender types and default rate It is argued that formal lenders serve the wealthier borrowers and informal lenders finance the poor household Since, semi-formal and informal lenders face higher risk level due to lack of creditworthiness of borrowers (Pham and Lensink, 2007 & Ghatak, 1983) Because of this, informal sectors require high risk premium, resulting in high cost of capital (interest rates) that leads the poor into the cycle of debt and poverty Many developing countries are facing this failure when rural credit market is not function well (Musinguzi &Smith, 2000) Nevertheless, formal institutions are unable to carter for all rural household’s demand due to their lending terms and conditions Hence, remained of client’s demand is flourished by the semi-formal and informal sectors

Table 3.2 below summarizes the main differences between informal credit sector and formal credit sector

Table 3.2 Comparison between formal and informal lenders

Formal sector Informal sector

Clients Targets Poor household Poor households

Basing on trust and personal relationship between borrowers and lenders

Source: report of VBARD and VBSP, 2012