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Life Impact | The University of Adelaide University of Papua New Guinea Economic Development Lecture 18: Financial Systems and Microfinance Slide 2 University of Papua New Guinea Slide 1 Lecture 18: Financial Systems and Microfinance Michael Cornish Overview Introduction Financial systems in developing countries The role of central banks Case Study: Hyperinflation in Zimbabwe Alternatives to a central bank Development banking Informal banking Reforming financial systems The role of stock markets Microfinance Case Study: Grameen Bank Slide 3 University of Papua New Guinea Slide 2 Lecture 18: Financial Systems and Microfinance Michael Cornish Introduction Prudential regulation Real sector/economy v financial sector/economy Which drives which? Answer: Likely both! Slide 4 University of Papua New Guinea Slide 3 Lecture 18: Financial Systems and Microfinance Michael Cornish Introduction Role of the financial sector: Payment services Middle-man for savers and investors Allocating credit efficiently Distributing information Managing risk Increasing asset liquidity: de-chunking Slide 5 University of Papua New Guinea Slide 4 Lecture 18: Financial Systems and Microfinance Michael Cornish Financial systems in developing countries Monetarists v Keynesians Monetarists: Expand money supply => directly induce economic activity Keynesians: Expand money supply => increase amount of money for lending => interest rates => investment => economic activity Slide 6 University of Papua New Guinea Slide 5 Lecture 18: Financial Systems and Microfinance Michael Cornish Financial systems in developing countries Problems in developing countries: Expanding/contracting money supply Affecting interest rates Why? Coordination issues Financial markets as islands Multinational focus Managed floating exchange rates Slide 7 University of Papua New Guinea Slide 6 Lecture 18: Financial Systems and Microfinance Michael Cornish Financial systems in developing countries Why? (cont.) Foreign reserves a high proportion of finance Currency substitution Information gaps Scarcity of funds Low sensitivity to interest rates Result? Duel monetary systems (to varying extents) Slide 8 University of Papua New Guinea Slide 7 Lecture 18: Financial Systems and Microfinance Michael Cornish The role of central banks Issue currency Manage foreign reserves Act as bank to the government Act as reserve bank to commercial banks Financial regulator Monetary policymaker Slide 9 University of Papua New Guinea Slide 8 Lecture 18: Financial Systems and Microfinance Michael Cornish The role of central banks Problems in developing countries: Human capital deficit Credibility issues Lack of political independence Beholden to imprudent fiscal policy Slide 10 University of Papua New Guinea Slide 9 Lecture 18: Financial Systems and Microfinance Michael Cornish Case study: Hyperinflation in Zimbabwe Hyperinflation = inflation > 50% per month Started in Zimbabwe in March 2007 1997 2007: Cumulative inflation = 3.8 bn % Living standards fell by 38% Effect on savings, financial capital Slide 11 University of Papua New Guinea Slide 10 Lecture 18: Financial Systems and Microfinance Michael Cornish Exchange rates: comparing the $Z with the Weimar Mark Slide 12 University of Papua New Guinea Slide 11 Lecture 18: Financial Systems and Microfinance Michael Cornish Case study: Hyperinflation in Zimbabwe Cause? Government fiscal policy Reserve bank has lost credibility, and thus ability to target inflation Attempted solutions: The denomination was changed Inflation was declared illegal (!!) Reserve bank continued to make declarations on its inflation targets... Slide 13 University of Papua New Guinea Slide 12 Lecture 18: Financial Systems and Microfinance Michael Cornish Notes from the now defunct $Z Slide 14 University of Papua New Guinea Slide 13 Lecture 18: Financial Systems and Microfinance Michael Cornish Case study: Hyperinflation in Zimbabwe Result? Foreign currencies adopted illegally Barter ...then foreign currencies adopted legally! Possible solutions? Dollarisation Currency board Free banking Slide 15 University of Papua New Guinea Slide 14 Lecture 18: Financial Systems and Microfinance Michael Cornish Slide 16 University of Papua New Guinea Slide 15 Lecture 18: Financial Systems and Microfinance Michael Cornish Slide 17 University of Papua New Guinea Slide 16 Lecture 18: Financial Systems and Microfinance Michael Cornish Alternatives to a central bank Currency board Transitional central banking institution Supranational central bank Outsourcing Pegging Currency enclave Open-economy central banking institution Activist banking Slide 18 University of Papua New Guinea Slide 17 Lecture 18: Financial Systems and Microfinance Michael Cornish Development banking Activist banking = development banking? Medium and long-term funds for industrial expansion Supranational development banks National development banks Direct involvement in enterprise but not small loans Slide 19 University of Papua New Guinea Slide 18 Lecture 18: Financial Systems and Microfinance Michael Cornish Informal banking Usury Income inequality Microfinance? Rotating savings and credit associations? Slide 20 University of Papua New Guinea Slide 19 Lecture 18: Financial Systems and Microfinance Michael Cornish Reforming financial systems Financial liberalisation? Money market price ceilings Financial repression Private efficiency v social efficiency Slide 21 University of Papua New Guinea Slide 20 Lecture 18: Financial Systems and Microfinance Michael Cornish Reforming financial systems Financial regulation: the Stiglitz list of market failures: Lack of public monitoring Institutional free-riding: overallocation and underallocation of funds Bank failure induces a run on the banks Missing insurance markets Abuse of market power Private v social returns Investment information gaps Slide 22 University of Papua New Guinea Slide 21 Lecture 18: Financial Systems and Microfinance Michael Cornish The role of stock markets Do they promote economic growth? Benefits: Increased liquidity Risk diversification Role for government? Reducing barriers to entry Slide 23 University of Papua New Guinea Slide 22 Lecture 18: Financial Systems and Microfinance Michael Cornish Microfinance Access to credit for investment: a way to help the poor plug the savings gap Why not normal finance? Administration cost Lack of collateral Slide 24 University of Papua New Guinea Slide 23 Lecture 18: Financial Systems and Microfinance Michael Cornish Case study: Grameen Bank Background: Muhammad Yunus (Banker to the Poor) Nobel Peace Prize 2006 Grameen Bank (Bank of the villages) Now has assets worth $750m Almost 25,000 employees Slide 25 University of Papua New Guinea Slide 24 Lecture 18: Financial Systems and Microfinance Michael Cornish Case study: Grameen Bank Features of Grameen Bank: Group lending Targets women (over 90%) Targets poor villages and households Small loans ($100 to $200) Weekly repayments Dual-purpose meetings Slide 26 University of Papua New Guinea Slide 25 Lecture 18: Financial Systems and Microfinance Michael Cornish Case study: Grameen Bank Positive matching: Good-risk people want to group with other good-risk people Risky people driven out Peer monitoring: Each member bears risk of all members projects Slide 27 University of Papua New Guinea Slide 26 Lecture 18: Financial Systems and Microfinance Michael Cornish Case study: Grameen Bank Drawbacks: Pressure to choose overly safe investment projects If one member has to default, all other members will want to default also Partial solution to default problem is to lend sequentially to group members Slide 28 University of Papua New Guinea Slide 27 Lecture 18: Financial Systems and Microfinance Michael Cornish