Pergamon

World Development, Vol. 24, No. 5, pp. 793-806.1996 Copyright 0 1996 Elsevier Science Ltd Printed in Great Britain. All rights reserved

0305-750x/% $15.00 + o.ocl 0305-750x(%)oooo1-0

Credit Constraints, Credit Unions, and Small-Scale Producers in Guatemala

BRADFORD L. BARHAM, STEPHEN BOUCHER and MICHAEL R. CARTER*

University of Wisconsin-Madison, USA.

Summary. - Efficient and equitable development outcomes may depend, in part, on whether formal financial institutions leave low-wealth producers tightly constrained in their access to credit. If so, can cooperative institutions efficiently relax these constraints? These issues are explored using survey data gathered from 950 small-scale producer households in areas of Guatemala with market-oriented credit unions that mobilize savings and make unsubsidized loans. Nonprice rationing by banks is found to be common among lower wealth households, while credit unions relax credit constraints for a significant portion of those rationed by banks, but not the poorest of the study households. Copyright 0 1996 Elsevier Science Ltd

1. INTRODUCTION As in much of Latin America, Guatemala is reducing state support for productive, service, and credit activities in agriculture and small-scale commerce. Concurrent financial market liberalization is aimed at improving the efficiency of financial market performance by increasing savings mobilization, the range of financial services provided, and credit access to productive enterprises and creditworthy consumers. Previous research, summarized in Adams and Vogel (1986), suggests that reducing government intervention in financial markets can allow more effrcient institutions to emerge, especially if key public goods, such as physical and informational infrastructure and a well-defined regulatory environment, are provided. This paper considers one aspect of financial market performance under liberalization, namely how cleaning the slate of government intervention is likely to affect the credit access of, or the credit constraints facing, low-wealth agricultural and commercial producers. Much of the answer hinges on the lending practices of formal and informal financial institutions. Do they leave low-wealth producers tightly constrained, i.e., unable to obtain credit at a going market rate, or even at a risk-adjusted rate? If so, can cooperative institutions, such as credit unions, help to meet the borrowing needs of these producers? Credit unions are of special interest, unlike borrowing groups and targeted lending programs, because they can be effective full-service intermediaries, which offer savings opportunities, make loans, and provide other financial services to members.
793

A rich body of theory has evolved to explore how incomplete information and transaction costs may prevent interest rates from clearing formal credit markets and lead to nonprice rationing. Key lessons from this research are developed in section 2 in three supply and demand diagrams of loan markets that begin with the strict assumptions of perfect information and zero transaction costs and then relax them to incorporate more realistic informational features of credit markets in developing countries. The discussion also highlights the need, in empirical work, to identify the potential loan demand of borrowers in order to ensure that conventional price rationing is not misinterpreted as some other form of rationing. Careful attention to the microeconomic features that shape lenders interactions with low-wealth borrowers helps to explain

*Paper originally prepared for the XVIII International Congress of the Latin American Studies Association. The authors offer their thanks to an anonymous referee, who offered useful suggestions on ways to improve the paper, and to Brian Branch, Barry Lennon, and David Richardson for their support and advice. The World Council of Credit Unions and the US Agency for International Development provided the financial support for the survey work underlying this paper. A team of Guatemalans worked hard to complete the survey work in a short time period, and we thank them and the respondents for their efforts. The authors also benefited from the remarks of seminar participants at the Inter-American Development Bank, Latin American Studies Association, University of Wisconsin, and World Council of Credit Unions. The data and survey instruments used in this paper are available upon request from the authors. Final revision accepted: November 16,1995.

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why credit unions might loosen constraints faced by some borrowers by lowering informational and monitoring costs typically associated with loan transactions. The potential benefits associated with credit union savings mobilization are not explored here, but previous work also underscores the value of innovations on this side of the financial market2 The empirical relevance of the distinct credit market outcomes developed in section 2 is then examined in later sections using a 1993 survey on the assets, enterprise activities, and financial market transactions of small-scale producer households in three regions of Guatemala.3 Market-oriented credit unions in these regions mobilize savings and make unsubsidized loans, with minimal use of external funds.4 The survey data are used to examine the relationship between credit constraints and wealth and particularly the role of credit unions in meeting the loan demand of lowwealth households. The latent demand of producer households is identified through their responses to questions on their needs for credit and their experiences with and perceptions of credit markets. Nonprice rationing of producer households by banks is found to be common and likely to weigh most heavily on low-wealth households. While credit unions appear to relax credit constraints for a significant portion of those rationed by banks, the poorest households are still to found to be quantity-rationed.

These clear links between wealth and credit constraints demonstrate the need for policy and research efforts which assist the development of viable, effective financial institutions, such as credit unions, that serve low-wealth households.

2. CREDIT MARKETS, INFORMATION, AND WEALTH This section identifies the microeconomic features of loan transactions which may prevent conventional price-rationing mechanisms from clearing credit markets, thereby making wealth-related credit rationing a likely outcome. The argument moves from a perfectinformation loan market, where the loan price effectively rations credit to all borrowers, to one of imperfect information and transaction costs, where price becomes an inadequate instrument for lenders to ration some or all borrowers. In the supply and demand diagrams presented in Figures l-3, individual loan size (L) is on the X-axis. The effective interest rate (r), representing the loan contract rate plus the transaction costs of arranging or executing the contract, is on the Y-axis. For borrowers with fixed capital (K), their demand schedule is portrayed as downward sloping, and for higher levels of K demand is higher.5 When a borrower cannot get

L=a(l+rJ

Ll

Figure 1.Loan access in ajidl information credit market.

CREDIT CONSTRAINTS the credit she demands at the prevailing contract rate, she can be viewed as credit-constrained, with the extent of the constraint given by the gap between the amount demanded and received.

795

(b) Loan markets with perfect informution andposi-

tive transaction costs

Securing information on prospective borrowers often requires fixed transaction costs (TC) that change the shape of the individual-specific loan supply curve. These costs arise in preparing loan applications, evaluating collateral and project viability, and monitoring credit use and repayment8 The downward-sloping portion of the supply curve S,(K,,/3J in Figure 2 shows that the effective interest rate - defined as [(l+r,)L+Tc]/L - is higher for small loans. The effective interest rate converges toward the contract rate, r,, as loan size increases. If the borrowers demand curve is D,(K,,), then she obtains a loan where the transaction costs are not large enough to raise the effective interest rate much above the contract rate. Indeed, any demand schedule in Figure 2 that cuts .S,(&,/lJ to the right of point G would yield essentially identical outcomes to those of Figure 1. If, however, the borrowers demand curve is D&J, then she is transaction-cost rationed, unwilling to pay the effective interest rate for a loan of any size (e.g., r, for a loan of size &). Because lenders are able to offer loan contracts to all classes of borrowers in this perfect information market, transaction-cost rationing could be viewed as a form of price-rationing. Semantics aside, Figure 2 shows that this form of rationing is systematically biased against low-wealth producers. It can leave them fully credit-constrained at the going contract rate for completely collateralized loans.

(a) Loan markets withpegect information and zero

transaction costs The curve S, in Figure 1 shows how a supply schedule would look in a competitive loan market where lenders face no risk of loan default. Individual demand would have no effect on the price, and the borrower would be able to secure a loan of any size at the going contract interest rate r,. The absence of transaction costs makes the effective interest rate and the contract rate identical. Given loan demand D,(K,J, the borrower would be able to secure a loan of L, at r,. Only price rationing would occur. Credit markets are, of course, quite distinct from commodity markets. Perhaps most fundamental is the fact that lenders face repayment risk because of the intertemporal nature of credit transactions. In practice, lenders have many ways to address default risk.6 For example, lenders could completely eliminate risk by requiring collateral whose value is equal to the loan plus interest payments. This would make for very limited credit provision though, especially in less-developed countries, where low wealth levels and insecure property rights leave many prospective borrowers with minimal collateralizable wealth. Another means of compensating for risk of default is to charge higher interest rates. When leaders know how likely each borrower is to default (and can costlessly monitor behavior to assure that no credit diversion occurs to change the default probability), they can combine the interest rate and collateral to ensure that the expected rate of return on individual loans equals the opportunity cost of the* funds. If the borrower has collateral of certain value C to the lender, the lender can provide a loan at the contract interest rate 0;) at no risk, up to the point where L( l+r,) = C (for a one-period loan). Beyond this threshold (point B in Figure l), lenders in a competitive market may compensate for the risk of the unsecured portion of a loan by charging a higher interest rate.7 As depicted in Figure 1, two borrowers with the same collateral and fixed capital stock could be offered different loan contracts based on the lenders knowledge of their heterogenous risk characteristics, represented by p, and a. Points C and D on their individual supply curves, S, and S,, show the distinct loan size and interest rate outcomes. In competitive equilibrium, the riskier borrower, with risk characteristics p2 gets a smaller loan at a higher rate. Thus, conventional price rationing is the outcome when individual risk is perfectly and costly observable.

(c) Loan markets with impe$ect information

The credit market depicted so far has assumed information on borrowers is either perfect and costless (Figure l), or perfect but with a fixed transaction cost to acquire that information (Figure 2). The seminal work of Stiglitz and Weiss (1981) spurred a line of research exploring the effects on equilibrium outcomes when relevant information on the riskiness of borrowers in prohibitively costly to acquire? Their analysis hinges on two sources of informational asymmetries. First, lenders may not be able to precisely identify the probability distribution of returns associated with each individuals project. Loan contracts tailored to the individuals risk profile (as in Figure 1) are thus not possible, and the lender must resort to boiler-plate contracts which offer identical terms to borrowers who are indistinguishable to the lender, but who are actually heterogeneous. Under such conditions, an increase in the boiler-plate contract interest rate beyond a certain level can leave a less desirable (riskier) pool of potential borrowers in the market, because the more desirable potential borrowers will be the first to be discouraged and squeezed out of the

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_~~~

L-C./(1 +rJ

Loaa.SiZC

Figure 2. Loan access in afull information andfixed transaction costs credit market.

market by the higher contract rate. In the face of such adverse selection effects, lenders may be unwilling to use higher interest rates to reduce excess demand. The second type of informational imperfection concerns lenders inability to monitor borrower behavior and credit use over the term of the loan contract. As the credit-rationing literature has explored, an increase in the contract interest rate under this circumstances heightens incentives for borrowers to divert credit to nonproductive uses. As with adverse selection, these adverse incentive effects or moral hazard problems associated with an interest rate increase discourage lenders from using higher rates to ration credit, and limit lenders abilities to use the interest rate as an instrument in undercollateralized loan contracts. As illustrated in Figure 3, quantity-rationing outcomes can arise when information on the relevant characteristics of borrowers is imperfect. For simplicity purposes, Figure 3 ignores the fixed transaction costs which generate the downward-sloping portion of the supply curve in Figure 2. The only information the lender is assumed to have on the borrower is their collateral level. Because of adverse selection and incentive problems associated with using higher interest rates to sort borrowers, Figure 3 assumes that loans are only made to borrowers at contract rates that go slightly above the risk-free rate r,. The supply curve OPP+ is the supply curve for a poor borrower, and

ORR+ is the supply curve for the rich borrower. The truncation points of these two supply curves are denoted by open circles at P+ and I?, and represent the point beyond which the adverse selection and incentive problems associated with interest rate increases reduce the expected return to the lender. Points P and R represent the threshold on the two supply schedules where the borrower has become overleveraged. The imperfect information loan market depicted in Figure 3 can give rise to excess loan demand or quantity rationing. In Figure 3, for example, neither the wealthy nor the poor borrower would be able to secure a loan large enough to get on their demand curve, with the poorer borrower obtaining Lsp and the richer borrower obtaining Ls,+ both at interest rate I+. Both borrowers are thus what are labeled below as partially constrained. Imperfect information thus creates the potential for quantity rationing which might be independent of wealth. Rationing associated with excess demand however, is more likely to be wealth-biased. One reason for this bias relates to the transaction costs of collateral collection in case of default. The effective leverage ratio of borrowers can be written as U(C K,), where TC, is the cost of collateral collection and the denominator is thus the net collateral offered by the borrower. If TC, has a fixed component, the effective leverage ratio will be lower for poorer borrowers. Indeed, it is possible that the net collateral value of a

CREDIT CONSTRAINTS

797

Effective

r+
I

LS, L, Lean Size LSrl LR Figure 3. ban access in an incomplete information market with adverse selection and incentive effects.

low-wealth borrower could be zero or even negative, if TC, is sufficiently large. In Figure 3, the poor borrower with demand curve D(K,) could have her supply curve rise at P-, or even be completely quantityrationed at 0 on the Y axis. The other two reasons for wealth biases in loan markets with imperfect information arise because lenders may use wealth to help distinguish the riskiness of different borrowers. First, repayment capacity under a negative income shock is likely to be lower for borrowers because of their inability to suppress consumption to meet loan repayments and because of their inability to establish a diversified asset portfolio. Given adverse selection and incentives, lenders may be less able to use interest rates as rationing devices for poorer borrowers. Thus, the supply curve may be truncated at a lower interest rate for poor borrowers, r- than for rich ones, r+.lO Finally, in highly inegalitarian societies, wealthier borrowers may be more visible and known to the owners and managers of lending institutions, based on experiences with one another in schools, clubs, neighborhoods, and social events. The relative anonymity of poorer borrowers means, in effect, that the cost of acquiring information on riskiness is negatively correlated with wealth, leading to a higher degree of rationing among the poor because of adverse selection. Four types of loan market outcomes have been identified. The first outcome is unconstrained. It can occur in any of the loan markets depicted in Figures l-3, depending on the location of the demand curve,

and would result for all borrowers, regardless of wealth, in a market with perfect and costless information. The second outcome is transaction-cost rationed, shown in Figure 2. The incidence of transaction-cost rationing is likely to be greater for low-wealth relative to high-wealth borrowers when loan preparation and execution require fixed transaction costs. The final two are partial and full quantity-rationing outcomes. They arise in loan markets characterized by asymmetric information and fixed transaction costs associated with collateral collection. As Figure 3 shows, these features can combine to bias quantity-rationing outcomes against low-wealth borrowers. Depending on the actual informational asymmetries, transaction costs, and distribution of wealth in a given locale, it is thus feasible that a substantial portion of low-wealth producers could be nonprice rationed in credit markets.

3. INSTITUTIONAL FORMS AND MARKET EFFICIENCY Given poorly developed legal systems and information infrastructure, credit market problems stemming from imperfect information and transaction costs seem quite likely in less-developed countries. Quantifiable information on the riskiness of prospective borrowers, especially small-scale producers, is costly to acquire. For example, financial records on enterprise activities, if available, will not be standard-

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ized or verifiable. Outstanding debt obligations may be unidentifiable, at least through formal channels. Collateral may not be fully secured, or be less secure than the paper work suggests. Much of the crucial information on the riskiness of borrowers will be inherently local, embedded in the experiences and interactions of residents. The ability of lending institutions to overcome information problems will thus be important in determining the degree of nonprice rationing or inefficiency in rural markets. In the case of Guatemala examined below, rural bank branch managers described a centralized credit review process, which relies primarily on quantifiable, comparable information provided by loan applications, evaluations of collateral, enterprise records, and project viability, and individual credit records. Even when local credit decisions are authorized, adherence to similar informational and documentation standards for purposes of intra-bank administration and review creates similar costs. Branch managers openly acknowledged the limits this costly review process imposes on their capacity to make loans to lower wealth producers (Boucher, Barham and Branch, 1993). Given these limitations on private bank lending, institutional innovation which lowers transaction costs and overcomes informational barriers could enhance financial market efficiency and incorporate previously marginalized low-wealth borrowers into formal financial markets. Credit unions have several features that can help them to lower transaction costs and improve the information available on a borrowers riskiness.i First, loan applications are reviewed locally by a volunteer committee made up of credit union members and credit union management. In addition to lowering the costs of review, this local process provides considerable collective knowledge about the riskiness of individual borrowers. They may be able to use a fuller range of information than bank managers on the borrowers full asset base and degree of diversification, and thus better estimate their ability to withstand negative shocks and repay the loan. They may have experience with or knowledge of the borrowers ability to succeed in a project, i.e. how talented they are and how hard they work. Local information thus helps to identify the ex ante risk of prospective borrowers and reduce transaction costs relative to banks. The problem of borrower anonymity, which underlies adverse selection, is thus reduced. Second, credit unions that successfully foster local cooperation can reduce inefficiency which results from information-based market failures. For example, the willingness of wealthier members to step forward as guarantors for poorer members, which may be enhanced by a sense of local cooperation, can serve as a signal of creditworthiness to loan reviewers. Credit unions can also be more efficient in monitoring and

enforcing loan contracts if they effectively combine local information and cooperation to ensure repayment. Because borrowers are near to other members, and known by other members, their project management and loan repayment behavior are readily observed and subject to greater moral sausion relative to the anonymous relations that exist among bank clients. The cooperative notion of were all in it together can solidify the effectiveness of moral suasion. This mixture of local information and cooperative incentives can make possible effective peer monitoring which reduces the adverse incentive problem. Credit unions also have a crucial feature that distinguishes them from other forms of cooperative lending organizations: they can legally offer an array of deposit services to mobilize savings which can in turn be intermediated to small- and medium-scale borrowers.r2 The savings mobilization dimension of credit unions may be the most crucial for insuring that loan repayments are taken seriously and effectively administered. When loanable funds are predominantly local savings, the security of members deposits depends on loan repayments, and proper representation of depositors interests in the cooperatives decision-making and administrative process becomes essential to the viability and credibility of the institution. Well-organized credit unions can reduce the informational asymmetries and scale economy problems of small-loan review and management and help the investment needs of low-wealth borrowers to be better met. At the same time, it is important to caution that there are many potential sources of local cooperative failure. One is the inability to diversify loan portfolios, if local productive activities are relatively homogeneous or sector-dependent. In this case, negative covariate shocks, such as bad weather or a decline in output price, can lead to widespread loan default, deposit-runs, and the loss of financial viability unless external insurance of some form is available.13 Others include the potential for corruption or cronyism to arise in the volunteer loan-review committee, the difficulty of maintaining a sense of moral obligation to the cooperative when membership grows beyond small numbers, and the difficulty of foreclosing in a cooperative institution in the case of an individual members default. Any of these problems can undermine the credibility of the institution, negating the advantages outline above. Nonetheless, the potential for failure that stems from the challenges of effective local collective action does not preclude the possibility that credit unions can improve the efficiency of financial markets and in the process generate more equitable outcomes. It only means that to do so involves a delicate challenge of combining both appropriate institutional design and effective local collective action. The diversity and depth of informal credit institutions in less-developed countries, and their ability to

CREDIT CONSTRAINTS

199

overcome inefficiencies in formal financial markets, has received increased attention in recent years (Bhatt, 1988; Christensen, 1993; Yotopolous and Floro, 1992). In Guatemala, loans from family and friends, money lenders, input suppliers, and merchant consignors are all important sources of credit, especially for short-term consumption or working capital loans. Informal sources have serious limitations, however, which make it unlikely that they will fully relax credit constraints, especially for producers. More specifically, while money lenders may enjoy informational advantages relative to formal institutions, their potential for deepening financial markets is limited, because informational problems and transaction costs are likely to rise as soon as the scope of their loan activity goes beyond a few individuals (Christensen, 1993). Their loanable funds are also likely to be scarce, as their inability to provide deposit services prevents them from mobilizing savings broadly for intermediation purposes. Moreover, if markets are poorly integrated, money lenders may exercise exceptional market power, raising the prospect of further inefficiencies through either explicitly or implicitly high interest rates (Bhaduri, 1977, 1983, Basu, 1984). In the Guatemala study areas, money lenders are generally viewed by borrowers as lenders of last resort, or for short-term emergency loans at high contract rates but with low transaction costs, rather than as lenders of first resort for production loans. Input supply loans, consignment loans, or contract-farming arrangements are examples of other types of credit relations that can reduce constraints facing producers. Still, there are potentially three important limitations of input supply or consignment loans, which could make them imperfect substitutes for formal loans. They tend to be in-kind which restricts their fungability; they tend to be short term, covering only the agricultural season or commercial cycle; and, depending on the competitive nature of local markets, they can come with relatively high implicit interest rates. In the empirical analysis, some attention is given to these types of loans, but their role in relaxing credit constraints in formal lending institutions is not explicitly addressed.

4. MEASUREMENT OF CREDIT RATIONING We now turn to the challenging empirical task of mapping the credit market outcomes depicted in Figures l-3 for producers in the study regions in Guatemala. Ideally, some measure of demand for individual producers would be compared with individual supply curves for credit, and producers would then be classified as fully constrained, partially constrained, or unconstrained depending on the outcome. Kochar (1992) takes loan application as a signal of demand, and then estimates credit access of different wealth

producers. Producer households who do not apply are assumed to be uninterested or unconstrained. Using this approach, Kochar finds strong econometric evidence that poorer households without credit are generally not constrained by credit markets but by the absence of investment opportunities given their low asset positions. An alternative approach is to estimate the shadow value of capital for producers and compare these with the prevailing market loan rates. Consistently large gaps between the shadow value of capital and prevailing loan rates reflect the presence of credit constraints. Sial and Carter (1994) adopt this approach, and find evidence of credit constraints for a relatively homogeneous groyp of peasant grain producers in Pakistan. This approach becomes difficult when there is heterogeneity of production activities both within and across households, because this method requires measuring rates of return for each activity. This measurement undertaking requires detailed quantitative information on revenues, costs, and technologies which in samples of heterogeneous producers, such as the study areas in Guatemala, may be prohibitively costly to collect. Methodologically, this paper builds on work by Feder er al. (1990) that explores the latent loan demand of households by asking them about their credit market experiences. In particular, nonborrowing households were asked the reasons for not borrowing or having been rejected, and borrowing households were asked whether they received their full demand or if they sought more credit than the amount they were actually granted at the going rate of interest. Responses to these questions were then used to classify households as fully, partially, or unconstrained in formal credit markets. One respondent group which is problematic to classify is those who did not apply for credit. One means of dealing with them is to do as Kochar (1992), who equated no application to no demand. As pointed out by Baydas, Meyers and Aguilera-Aldred (1992), however, while some nonapplicants truly have no demand at the perceived contract rate, others who would demand a loan did not seek one because transaction costs made them too expensive or they believed that banks would reject them for reasons of insufficient collateral. The survey deployed in this study asked questions that allowed these two groups to be distinguished. Two fundamental selection issues had to be incorporated into the study design in order to accurately assess the importance of credit unions in easing credit constraints in formal credit market institutions. The first selection issue was that of potentially confounding a vibrant local economy with the presence of a credit union, where the former might have more to do with higher levels of credit access than the latter. The second was that of potentially confounding credit access with credit union membership, where. those households desiring credit join credit unions and those

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with less or no demand, do not (Sial and Carter, 1994). These selection issues are addressed in three ways: (a) by including as respondents a natural experiment sample of credit union member households, non-member households, and control households who live nearby, but are outside of the credit unions marketing area; (b) through the use of questions on the latent demand of respondents for credit and their experience in, or perception of, credit access in formal credit institutions; and, (c) by controlling for wealth in comparisons of credit access and constraints among respondent households. Combined, these features of the study design allow for comparisons between the different types of producer households, yet also control for differences in demand for credit that might arise because of variations in surrounding economic opportunities, household objectives, and household wealth. Detailed financial data were collected from all surveyed households, including information on household farm and business activities, assets (land, residential and business structures, business and personal equipment, animals, and financial assets),r4 savings and borrowing transactions with both formal and informal sources, and household perceptions of their formal sector borrowing opportunities. The surveys also documented household composition, labor market participation, and credit union membership. Three credit union areas were chosen to represent a range of the broad spectrum of Guatemalan financial markets.r5 All three had relatively active and dynamic agricultural and commercial sectors. Only households with agricultural and/or commercial enterprises were interviewed, i.e., households with only wage workers were excluded.i6 Households were selected from both urban and rural areas surrounding the credit union town, without consideration for membership status. In total, 950 households were surveyed, with an average of slightly over 250 in the three credit union areas and 90 in each of two control towns. Of the 761 households interviewed in the three credit union areas, 294, or 39%, were member households, while 467, or 61%, were nonmember households. Membership rates were considerably higher among urban households (over 50%) than in rural households (under 25%). Two wealth comparisons from the survey data underscore the potential importance of the selection issues just mentioned and the sample design used to address them. First, the average wealth of the households in the control villages (about $16,000) was about half that of respondents in the nearby credit union areas (about $32,000). These differences in mean wealth suggest that households in the credit union areas are in a more vibrant local economy, and thus may have more demand for credit. Second, in these same areas, credit union member households also have higher wealth (about $37,000) than nonmember households (about $27,000), which also suggests the possibility of differences in loan demand.

The empirical argument is presented in two steps. First, summary statistics of credit market outcomes are used to develop a comparative profile of credit access and terms for credit union members, nomnembers, and control respondents. The data in section 5 show that the presence of credit unions is associated with higher credit access for low-wealth producer households and more competitive local credit markets. Since this first step does not control for demand among respondents, strong conclusions cannot be drawn about whether households have credit constrains relaxed by credit unions. The next step in the argument is to examine the credit market experiences and perceptions of respondent households, and how they are associated with household demand and wealth levels. To simplify the presentation, this step is demonstrated in section 6 for only one region, where respondent wealth levels are considerably higher than in the other two. Barham and Boucher (1994) show that similar results hold for the poorer credit union areas.

5. TERMS AND ACCESS TO CREDIT AMONG SMALL-SCALE PRODUCER HOUSEHOLDS The first comparison of credit access and terms is presented in Table 1. Among the 189 producer households sampled in the two control areas, 83 loans were received during 1992 (or about one loan for every 2.5 households); none of those loans came from private banks, 11 came from public banks, and 10 from credit unions. Over 75% of the loans to control households came from nongovernmental organizations (NGOs) operating in the two areas. By contrast, among the 761 producer households sampled in the credit union areas, 482 loans were received (or about two loans for every three households). Formal sector loans (banks and credit unions) represent almost 60% of all loans, while credit unions account for 75% of formal loans. For all loan sources, the average loan size in the credit union areas was just about twice the level of the control areas, 4,800 versus 2,400 quetzales, (5.2 quetzales = $1 US), and the average size of credit union loans was 5,853 quetzales. On a per household basis, the volume of credit obtained by respondents in credit union areas was about three times that of respondents in the control areas. Interest rates and term lengths were also more favorable to borrowers in the credit union areas. In the control areas, the average annualized interest rate on all loans was 30%, compared to 24% in the credit union areas. The average term length for loans in control areas was 326 days, with over half of the loans having a term of under half a year, versus an average term of 535 days in credit union areas. Money lender loans comprised about 15% of the loans, and were made at an average annualized rate of 78% in control

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801

Table 1. Loan volumes and characreristics Loan source Credit union areas Credit union-total private bank-total Public bank-total Irlfomlal-total Moneylender Family/Friend NGOGO Other informal Total Control areas - 189 households Credit union-total Public bank-total Infotlnal-total Moneylender Family/Friend NGO/GO Other informal Total *Annualized rate. t5.2 quetzales = U$l, 1992). Loan 3% 758 households 207 15 54 206 48 87 55 16 482 Loan

size (quetzales)
4.9507 14,553 5,810 2,788 5,339 1,086 2,995 3,669 4,809

Interest rate*

Term of loan (days)

23% 21% 19% 26% 67% 8% 26% 7% 24%

570 1,332 984 314 258 166 396 951 535

10 11 62 12 13 32 5 83

4,950 3,668 1,780 1,008 960 1,364 8,430 2,412

24% 19% 33% 78% 5% 29% 14% 30%

666 560 228 108 449 177 310 326

areas. This compares with 10% of the total loans, made at an average interest rate of 67% in credit union areas. The high rate on money lender loans supports the view that they provide an imperfect substitute for formal loans. One other major source of credit, supplier and consignment loans, was evident in the respondents financial transaction reports. In the three credit union areas, mote than 20% of households received inputs or merchandise advanced as credit during the past year, and for about 10% of households these in-kind loans were their sole form of credit. The value of supply loans tended to be fairly large. For example, in the South Coast region, the average value of supply loans was about 3,900 quetzales, compared to an average credit union loan of nearly 7,100 quetzales. For the entire sample, the average term length of credit from suppliers was short, 23-29 days for commercial goods and 75-U days for agricultural inputs. A quarter of the suppliers offered a discount of about 7% for cash payments on delivery. When converted to annual terms, this implicit interest rate is even greater than money lender rates.t8Thus, given both their term structure and their potential for high implicit rates of interest, input supply and consignment loans may also be an imperfect substitute for formal loans for producer households, especially if they are seeking to make longer term investments. The credit access patterns of member, nonmember, and control households are compared in Table 2, which shows by wealth quintiles the percentage of each type of household with credit access for the

South Coast region. The second column reports the percentage of households in a given wealth quintile, and the rest of the columns give the percentage of households that receive a loan from each source. A first glance at Table 2 shows that access to any loans is higher for credit union member households across all wealth quintiles, and especially in the lower ones. The any loan column shows that 53 and 76%, respectively, of member households in this first and second quintiles has a loan. Over 90% of these were credit union loans. In contrast, less than 10% of nonmember households in credit union areas and less than 25% of households in the control area, in the same quintiles, had a loan. For nonmember and control households in the lower wealth quintiles, supplier loans are the principal source of credit. In summary, combining all sources, member households have much greater credit access. The presence of a credit union is associated with greater credit access by lower wealth producer households, but the same cannot be said for banks. Fifty credit union loans were made to households in the bottom three wealth quintiles compared to only two bank loans. Even among respondents at the top of the wealth spectrum, credit union loans are more prevalent than bank loans. These comparisons are suggestive but not conclusive, because the relatively low loan access of nonmembers could be attributed to lack of demand or lower creditworthiness. The next section addresses the demand issue by exploring the credit market experiences and perceptions of respon-

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Table 2. Loan access by household wealth quintile and membership statusfor South Coast credit union and control areas
Credit union area (N = 211 households) % Credit Union Member Households % Member Hhlds in Quintile 13% 18% 23% 26% 19% Credit with (N = 114) Any Loan or Supplier Credit 53% 81% 85% 83% 55%

Wealth Quintile 1 2 3 4 5

Union
Loan 47% 71% 69% 70% 36%

Bank Loan 0% 0% 4% 7% 18%

Informal NGO 7% 5% 8% 13% 5%

Any Loan 53% 76% 69% 73% 45%

Supplier Credit 13% 48% 46% 47% 36% with (N = 97) 15% 48% 29% 8% 15%

% Non-Credit Union Member Households 1 2 3 4 5 28% 22% 18% 12% 21% 0% 0% 0% 0% 0% 4% 0% 0% 17% 35% 4% 5% 6% 8% 5% 7% 5% 6% 25% 40%

22% 53% 35% 33% 55%

Control area (N = 88 households) % Households 1 2 3 4 5 20% 20% 20% 20% 20% 6%* 0% 0% 0% 0% 6% 0% 6% 0% 22% 11% 12% 11% 6% 11% with 22% 12% 11% 6% 28% 22% 24% 33% 18% 28% 33% 29% 39% 24% 39%

*One respondent in the control area traveled the 30 kilometers to the credit union area to become a member.

dents and explicitly examines whether credit unions help low wealth producers to overcome credit constraints in banks.

6. CREDIT CONSTRAINTS, WEALTH, AND CREDIT UNIONS The analysis builds on a series of questions concerning respondent borrowing needs, experiences, and perceptions. The primary purpose of the questions was to identify whether households were credit constrained in the major formal lending institutions: credit unions, private banks, and public banks.19 Households were asked if they had pursued loans at each of these institutions. If they had, they were asked, in the case of rejection, what the explanation for their rejection was. In the case of acceptance, they were asked whether they had received the loan amount they requested or wanted. If they had not pursued formal sector loans, they were asked why not. Responses were used to group respondents into three group response categories, corresponding to the

outcomes described in section 2. The categories and the responses which led to classification in each category are: (a) Fully constrained: Either applied and were rejected or did not apply due to: - insufficient collateral or the inability to document sufficient asset holdings to secure or collateralize the loan; - high transaction costs, i.e., the costs of obtaining property titles, compiling enterprise projects or paying other loan fees made the effective cost of the loan prohibitive; and, - fear of risk, specifically the loss of their wealth prevented them from pursuing a loan (This group was included as fully constrained on the presumption that the absence of insurance or other risk-reducing mechanisms forced them to self-insure. It was the smallest of the three categories, and their average wealth was much lower than all the other groups.) (b) Partially Constrained: Received a loan but for less than requested or wanted given the loan terms. (c) Unconstrained: Either received full loan amount or had no interest in a loan.

CREDIT CONSTRAINTS The results of this exercise are mapped in Figure 4 for the South Coast credit union area, according to the proportion of respondents in each category and their average wealth. Average household wealth for the 201 respondents is 253,787 quetzales. This can be used as a basis for comparison of loan market opportunities and constraints of the rest of the figure. The grouping of respondent households begins with the division of households into the Did Not Apply and Did Apply portions. Subsequent categorization depends on how respondents answered the credit experience questions on the private bank portion of the survey. Thus, for example, 64% of the respondents were unconstrained in access to bank loans, and 32% did not apply, but did not for one of the three reasons given above under the fully constrained category, with more than half of these claiming that they had insufficient collateral to secure a bank loan. Two percent did apply, and were denied bank loans. Finally, 3% applied and received what they had requested from the bank. In this sample of private bank loans, there were no partially constrained observations. Comparisons of these categories support the conjecture that poorer households are more likely to be tightly credit constrained in private banks. Those who considered themselves constrained, but did not apply, had an average wealth of 127,979 quetzales, which is a little less than 40% of the wealth of those who con-

803

sidered themselves unconstrained and also did not apply for bank loans. This constrained cohorts average wealth is also less than one half of the average wealth of the unconstrained group who received a loan. The other constrained cohort that did apply actually has a higher average wealth level than those who received loans from banks, which supports the notion that wealth may be necessary but not sufficient for securing credit access. Similar differentiation of constrained and unconstrained households by wealth is evident in the other regions.2o The next set of comparisons address whether credit unions help to relax the credit constraints faced by poorer households in banks. Specifically, the bottom of Figure 4 identifies the proportion of the households from the two constrained boxes in the upper portion that have credit constraints relaxed by the presence of credit unions. These bank-constrained households have an average wealth of 137,897 quetzales. Over 40% have their formal credit constraints relaxed in the credit union, combining the 13% reporting as unconstrained (but applied for a loan) and the 27% reporting as partially constrained. These two groups average about 182,000 quetzales in wealth, which is a third less than the overall sample average for the region, but more than the average for these bank-rationed households. Another 28% of bank-rationed households, or 9% of the South Coast sample, report being fully con-

Private Bank Loan Experiences (N =201) Average Wealth =253,787 quetzales (5.2 quetzales = l$, 1992)

Did Not

Apply

Did Apply

Experiencein Credit Union of Those

Constrained in Banks (N = 67) Average Wealth = 137,897 quetzales Did Not Apply

I Unconstined
31% Ave. With. 140,977 Fully COnshained 22% Ave. With. 96,055 Fully Constrained 6% Ave. Wlth. 44.184

27% Ave. Wlth. 168,828

Ave. WM. 190,316

Figure 4. Credit rationing in South Coast area, Guatemala.

804

WORLD DEVELOPMENT

strained within credit unions. Their average wealth is 85,680 quetzales, or about one-third of the regional sample average, and less than two-thirds of the average for bank-rationed households. Finally, 31% of bank rationed households report being uninterested in credit union loans, and their average wealth is slightly higher than the sample average. The outcomes in Figure 4 provide the basis for three major conclusions. First, 14% of respondents in the region have credit constraints in private banks partially or fully relaxed in credit unions. Second, while credit unions are important in relaxing credit constrains for low wealth producers, their coverage does not reach the lowest end of the wealth spectrum. For the entire sample, about 10% of households report being credit constrained both in private banks and credit unions. Third, a significant portion of credit union loan recipients are partially constrained. In sum, credit unions play a crucial role in improving credit access of lower wealth producers, but they may be unable to serve the needs of the lowest wealth borrowers. For &xlucer households at the bottom of the wealth .+ctrum, other types of local cooperatives, such as group lending schemes, may need to be fomented to improve credit access (Wydick, 1994; Huppi and Feder, 1990).

rowers. Start-ups require initial investments in organization, management training, membership recruitment, and creation of a secure, healthy institution to attract depositors. These fixed costs may be large compared to the resources that a community can generate via collective action. External agencies interested in helping to meet these fixed costs also need to recognize two other major challenges that credit unions face. One is their vulnerability to local economic shocks which may provoke simultaneously high levels of loan defaults and runs on demand deposits. This suggests the need for diversification of investments and coordination of credit unions across regions. The second challenge is that, in some areas, credit unions must overcome a poor image, because earlier credit union efforts relied extensively on external funds for lending and did not develop a sustainable balance between effective local savings mobilization and well-administered credit management or were undercut by inflation or instability in the macroeconomy. In these cases, the fixed costs of managing a structural adjustment program or an organizational overhaul may be even larger than starting up a new credit union, and external support may be needed to both restore credibility and to reor-

ganize .
Creation and reform of credit unions is an area where government or nongovernmental support might be warranted, with the aim of creating a self-sustaining organization within a limited time frame. Such an effort could be consistent with the broad critique of state intervention, as the main objective would be to create decentralized, market-based intermediaries, but with an explicit aim of meeting the savings and credit needs of lower wealth households. At the same time, the challenge for the local community would be to move from start-up or initial reform to a well-functioning civic institution that fills a significant gap in financial markets for low-wealth households. This is the type of effort from whence local democratic development could well spring.

7. CONCLUSION This paper gives reason for hope that credit unions can help improve the efficiency of local financial markets and the prospects for equitable economic development in Guatemala. Currently, under 10% of the Guatemalan population is served by any credit union, let alone one that is vibrant in its local financial intermediation role. Thus, the upside potential for institutional innovation in reforming traditional credit unions or creating new ones could be quite high. Credit unions however, do not spring up merely because of the social need for better financial market intermediation for lower wealth depositors and bor-

NOTES
1. At issue are both the efficiency and the equity of the operation of the economy in static and dynamic terms. Barham, Carter and Sigelko (1995) and Carter, Barham and Mesbah (forthcoming) demonstrate, in both the short and long term, the importance of capital access in Latin America for small-farmer participation in agro-export crop production and their competitiveness as producers. 2. Credit unions may fill an even more important need for poor households in developing countries by providing them a secure place to save and receive positive real rates of return on their deposits. See Carter and Boucher (1995). von Pischke, Adams and Donald (1983), and Adams and Vogel (1986) for more on the potential importance of savings services to poor households. 3. This paper is based on an independent evaluation done for the World Council of Credit Unions, in conjunction with the US Agency for International Development, of a recent structural adjustment program carried out by Guatemalan credit unions. See Barham and Boucher (1994) for the report to these agencies. 4. About 20 Guatemalan credit unions, including the

CREDIT CONSTRAINTS

805

three in this study, underwent structural adjustment in the late 1980s aimed at making them self-sufficient in a competitive market. See Richardson, Lennon and Branch (1993). Based on a constant-returns-to-scale production tech5. nology with fixed assets, loans to finance variable costs lead to a downward-sloping demand schedule. Assuming insufficient private liquidity to self-finance the need for variable inputs justifies the shifting of the demand schedule to the right for producers with more fixed capital. Finally, given uncertainty and incomplete insurance markets, demand at a given interest rate would reflect the borrowers risk-adjusted rate of return. As an anonymous referee pointed out, lenders can also 6. shorten the term structure, tie the loan to other market transactions, or off-load on the borrower part of the lenders normal transaction costs. For some distance beyond B, the compensating rise in I. the contract interest rate could be small, making the effective interest rate very close to r,. For clarity in Figure 1, the schedule is shown as rising immediately after B. In practice, transaction costs can be incurred by both 8. the lender and the borrower. To simplify the presentation, all transaction costs of producing and servicing a loan are reflected in the supply schedule. Braverman and Guasch (1986) and Hillier and 9. Ibrahimo (1993) summarize the theoretical literature. Besley (1995) offers a less technical, policy-oriented discussion of the informational basis for credit market failures. 10. In a market with excess demand, wealthy borrowers can have their demands met while the lower wealth borrowers are completely rationed out. Carter (1988) argues that small farmers are more likely to confront this form of redlining in dualistic agrarian structures, where wealthy borrowers may absorb the available loan supply. 11. Poyo, Aguilera and Gonzalez Vega (1992) discuss the design features of credit unions as they evolve from the small club stage to the bank stage where increased membership size and declining risk-screening capacity push them toward a more formal loan review and monitoring process. 12. Savings mobilization depends on a combination of competitive rates of return on deposit relative to other tinancial intermediaries, services to meet the various liquidity needs of customers, and a culture of financial savings among the membership. This latter point is important given the his-

toric reliance of many (potential) cooperative members on savings in the form of grain and livestock as insurance against hard times. Boucher, Barham and Branch (1993) found that savings deposits in Guatemalan credit unions are highly concentrated among wealthier members. 13. See Carter and Zegarra (1995) for a discussion of the proper balance between policies oriented toward building effective local management of credit unions and providing external insurance against covariate shocks. 14. The value of stored grain is not included in me asset measure, which may somewhat bias asset estimates for the poorest rural households in the sample. Financial assets may also be underreported, but this bias is likely to lead to an understatement of wealth differences across sample households for reasons discussed in note 12. 15. The three areas were Tiquisate, on the South Coast, San Juan Sacatapequez, in the Central Highlands, and Tat Tic, in the Northern Highlands. Barham and Boucher (1994) describe the areas and activities of producers. 16. Credit unions also serve wage workers by offering deposit services and housing and consumer loans. 17. The differences in loan volumes between the credit union and control areas would have been greater, if not for NGOs in the control areas, who were operating there explicitly to address local credit access problems. 18. Implicit interest rates of this magnitude may be present in the price structure of some other supplier credit loans, but comparable data on alternative input sources and cash prices were not solicited to test this question. 19. Public bank loans were found only among the wealthiest of respondent households in the South Coast. 20. This wealth-based interpretation of credit constraints could be problematic if there is a negative correlation between wealth and risk for individual borrowers, based on the riskiness of their projects or their personal character but not on their wealth per se, and if these features are observed by banks but not the researchers. If, however, the risky characteristics of projects and personal character are not readily observed by banks, or there is no negative correlation between these characteristics and wealth, then the outcomes would be consistent with the overall argument of the paper, whether or not poor borrowers are per se creditworthy.

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