The Importance of Credit Markets in the Developing World

Access to capital is the key to economic development. However access to the biggest source of capital, credit markets, remains out-of-reach for millions of people.

The Importance of Credit Markets in the Developing World

If you try to think of the key ingredients to economic development in developing countries, you’d be forgiven if access to credit didn’t instantly spring to mind. Certainly, access to food and water constitutes a basic and fundamental necessity. Whilst education is rightfully considered a cornerstone of economic development too.

But loans, despite their relatively unfashionable status when compared with something like access to education, nonetheless provide an essential service throughout the world. Put simply, they allow entities of all kinds to raise capital. Whoever, or whatever you are, access to capital is the key ingredient of growth. Whether it is country, a business, or a person, access to capital makes the world go round.

Whilst access to personal loans might not strike you as comparable to something like access to basic infrastructure, if we consider how that infrastructure is funded, well then it starts to make sense. Most countries, both in the developing and developed world, fund infrastructure development through taking out loans on international markets. In other words, credit enables entities to improve their long-term economic prospects.

And normal people are no exception to this rule. In most developed countries, affording a house requires a mortgage. Meanwhile small businesses and start-ups often rely on loans to meet their initial financing needs and make investments to kick-start their businesses. In the UK, between 2012 and 2020, the state-owned British Business Bank provided over 75,000 small loans for these small businesses to try and encourage economic growth.

In one sense, Gluwa is no exception either. Gluwa has raised capital from investors to develop economic services and build a profitable enterprise. Whilst private investment is obviously different to a loan, the principle is the same. Party A provides capital to Party B with the expectation of a return. Meanwhile idle capital is transformed into something which generates economic returns and growth.

But, whilst government’s and large businesses in the developing world have access to credit, the same cannot be said for millions of other people and the businesses they run.

In Nigeria for example, small/medium enterprises (SMEs) account for 96% of businesses, 84% of employment and contributed 48% of GDP. Yet, despite their dominant role in the economy, only 20% of small-medium enterprises (SMEs) had access to any kind of credit, with only 5% of Nigeria’s total loan portfolio allocated to these businesses. Without access to credit, millions of these companies cannot invest in the capital needed to grow their businesses and turbo-charge growth.

Indeed, across Africa, limited access to credit is cited by firms as the most severe factor constraining their economic growth, more severe than corruption, political instability, and even access to basic services such as electricity. The scale of this financing shortfall is so severe, that there are an estimated 131 million micro, small and medium enterprises globally, with unmet financing needs worth $5 trillion.

But the problem is hardly a new one. The fact that limited access to capital (in other words loans), represents a significant barrier to economic development has long been understood. A particular problem for poorer communities who have no access to traditional financial services like we do in the developed world.

To solve this, a man named Muhammad Yunus developed the concepts of microfinance and microcredit to boost growth in his home-country of Bangladesh. His organization, the Grameen Bank, provided small uncollateralized loans to millions of people, often women, to help start their businesses and escape the poverty trap. This novel approach of providing uncollateralized lending to people in the developing world was so deemed so revolutionary and influential in helping people escape poverty, that he received a Nobel peace prize for his pioneering efforts in the field.

Indeed, the microfinance Industry has only grown since then, and is expected to grow by another $196.4 billion by 2025. Microcredit is provided by dozens of banks to millions of people around the world, yet the industry still has a long way to go. Globally, a whopping 1.7 billion people are considered ‘unbanked’, having no access to basic financial services such as loans. Continued efforts to expand financial inclusion are imperative in unlocking the economic potential of developing nations.

But what exactly are the obstacles to credit in the developing world and why does the global financing gap remain so large?

For the ‘why’, two primary factors seem to play a major role...

Firstly, banks have lacked the necessary infrastructure to provide loans. They may lack the capital, the expertise, or even simpler, an actual branch within geographic reach. Not only this, but many of the things we take for granted, such as formal identification, passports, and other such records, are simply lacking in many developing countries. Banks cannot provide loans to people they cannot reach, cannot identify and cannot fund.

Secondly, the problem is one of poor market information. Without access to ‘thick’ financial records, such as credit scores, banks cannot reliably assess the risk of potential clients and are thus unwilling to lend. The OECD has noted that SME’s lack of “credible financial records” represents their primary obstacle to credit, and that resolving these information asymmetries is key for expanding the availability of financing instruments.

Particularly when loan amounts are small, as is common in the developing world, even just the costs of assessing risk outweigh the benefits, ensuring that access to formal financial services has been limited to larger businesses, wealthy individuals, and governments etc.

The problem is even greater for international lenders who might seek to deploy their capital in high-growth developing markets, but who lack any kind of local market expertise, and are thus unable to invest their capital without considerable risk exposure and uncertainty.

As a result, increasing the availability of accurate financial information must be considered of paramount importance. By improving market information. and therefore reducing uncertainty, the deployment of the capital needed for economic success will be unlocked.

Naturally, this is the problem which Creditcoin can solve. And in so doing, unlock the economic potential of developing markets and help drive global financial inclusion forwards.

In the following article, we will discuss how technological developments are affecting these problems and enabling a new financial revolution in developing countries.

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