Ashraf Rehman
One of the most critical questions posed in the ongoing debates and discussions on financial inclusion in India is, “Who actually accesses formal credit and why?” The current empirical findings provide an essential and well-timed contribution to the above debate by focusing its interest not on institutions but on borrower behaviour and capabilities, in particular those of the poorly covered North Eastern Region (NER) of India.
The core of the research is a simple yet essential idea: access to credit depends not only on the supply of finance but also on people’s skills, knowledge, and attitudes towards the financial system.
In other words, the problem of financial literacy is more than a mere recommendation—it is a crucial factor. It is particularly relevant because it disputes a persistent myth of policy-making, namely the belief in the direct link between the expansion of the banking sector and financial inclusion.
Financial Literacy: The Missing Link
There is no doubt now that financial literacy is the biggest determinant in the ability of entrepreneurs to get loans from formal institutions. Those who have undergone training in financial literacy are much more likely to get loans from banks. The importance of this finding cannot be understated.
This finding reveals that credit constraints do not only emanate from structural constraints such as the absence of bank infrastructures, but also from information constraints. Most people who cannot access loans are not excluded from loans due to the refusal of banks to lend, but due to the lack of information on how to access these facilities.
In areas like Northeast India, where geographical isolation makes it difficult to have bank branches in the area, this information problem is particularly important. Lack of information about the loan application process, eligibility requirements, and repayment policies means that many people effectively bar themselves from accessing loans.
The Shadow of Information Asymmetry
In this context, the research takes advantage of the well-known theory of information asymmetry, which reflects the inequality of knowledge of parties involved in market transactions. In the case of the credit market, the asymmetry of knowledge is usually biased towards creditors. If an entrepreneur does not have any information on the financial instruments, he is unlikely to apply for a loan, whereas the bank is going to be unsure of the quality of the borrower.
An additional aspect adds an interesting twist to the concept of information asymmetry by introducing borrower asymmetry. Instead of discussing the reluctance of lenders solely, this approach explains how the deficiency of financial knowledge affects borrowers and makes them avoid participating in financial activities. Financial literacy is thus an instrument that helps in overcoming uncertainty and establishing trust in the market environment.
It is crucial for countries with developing economies because of the lack of trust in institutions and limited experience with financial tools. Policy makers thus can solve not only economic problems but also behavioural and psychological ones related to a lack of participation in financial activities.
A Surprising Behavioural Insight
One of the most fascinating observations in the paper is the relationship between business profitability and access to credit in the reverse direction. Unlike popular opinion, the more profitable the business, the less probable it is to take loans from banks.
The observation resonates with the principle of “pecking order,” which states that firms would rather use their internal funds than resort to external borrowing. Small entrepreneurs, particularly operating under unpredictable circumstances, feel safer using retained earnings as opposed to dealing with all the complexities of banking operations. Borrowing in an entrepreneurial environment can be viewed as a risky and uncertain activity that most business owners would like to avoid if they have enough internal funds available.
This contradicts the commonly accepted notion that increased profitability leads to increased demand for credit. Behavioural considerations play a significant part here.
Banks Still Dominate—but Growth Is Slowing
In terms of the supply side, the research finds that commercial banks still provide the major share of financing of MFIs, comprising about 50% of all credit provided within the last fifteen years, due to their better capital base, organizational capabilities, and outreach in comparison with other financial organizations.
It should also be noted that even though the volume of lending steadily grows, its growth rate tends to slow down. Such a tendency indicates that the development of microfinance could already be at a certain stage when fast growth is not ensured anymore, and maintaining the pace would require certain efforts. It could also be seen that during specific periods, for example, the period of the global pandemic, there were changes in the dynamics of credit provision, which also show how sensitive this process is to various factors. However, it could be seen that after the pandemic, the dynamics of credit provision recovered.
Bridging Demand and Supply
The strength of this research is that it uses an integrative strategy of analysis by considering the aspects of borrower behaviour from the demand-side perspective, along with the trends in institutional lending from the supply-side perspective. The use of the integrative strategy for this research gives us a well-rounded view of the credit market environment. In one way, the financial institutions have an important role to play in providing access to credit.
In another way, there should be borrowers who would be willing and ready to take advantage of the credit facilities provided. If there is some deficiency from any of these perspectives, then the credit market environment will be suboptimal. This research proves that although there may be credit facilities available, there are barriers to accessing it because of lack of financial literacy.
Policy Implications: Beyond Access to Awareness
This initiative for “Financial Literacy and Credit Facilitation Hubs” stands out. These platforms would provide both educational and real-time help, thus encouraging borrowers to act upon their knowledge. By giving assistance in practice, these financial literacy hubs would minimize process-based hurdles and give assurance to new borrowers.
In areas like northeast India, where there are both physical and information-based barriers, such measures could help bring about an increase in the number of people participating in formal financial systems.
Ashraf Rehman is a Fellow at The Green Institute and a columnist.
This opinion article is based on the Author’s published work titled “Who Gets the Credit and Why? Information Asymmetry, Borrower Behaviour and Lending to Microfinance Institutions in India” in Small Enterprises Development, Management & Extension Journal by Sage Publications
