Covariant Risk and Segmented Markets
A special feature of agriculture, which provides the income of most rural
residents, is the risk of income shocks. These include weather fluctuations that
affect whole regions as well as changes in commodity prices that affect all the
producers of a particular commodity. Such shocks affect the operation of credit
markets if they create the potential for a group of farmers to default at the
same time. The problem is exacerbated if all depositors simultaneously try to
withdraw their savings from the bank. This risk could be averted if lenders
held loan portfolios that were well diversified. But credit markets in rural areas
tend to be segmented, meaning that a lender's portfolio of loans is concentrated on a group of individuals facing common shocks to their incomes-in one
particular geographic area, for example, or on farmers producing one particular crop, or on one particular kinship group.
Segmented credit markets in the rural areas of developing countries often
depend on informal credit, such as local moneylenders, friends and relatives,
rotating savings, and credit associations. Informal credit institutions tend to
operate locally, using local information and enforcement mechanisms.
The cost of segmentation is that funds fail to flow across regions or groups
of individuals even though there are potential gains from doing so, as when
needs for credit differ across locations. For example, a flood may create a significant demand for loans to rebuild. But because credit institutions are localized, such flows may be limited. Deposit retention schemes, which require that
some percentage of deposits raised be reinvested in the same region, or the
practice of unit banking may exacerbate the segmentation. Finding the optimal
scope of financial intermediaries may require a tradeoff. Local lenders may
have better information and may be more accountable to their depositors than
large, national lenders. However, the latter may have better access to well diversified loan portfolios.
Covariant Risk and Segmented MarketsA special feature of agriculture, which provides the income of most ruralresidents, is the risk of income shocks. These include weather fluctuations thataffect whole regions as well as changes in commodity prices that affect all theproducers of a particular commodity. Such shocks affect the operation of creditmarkets if they create the potential for a group of farmers to default at thesame time. The problem is exacerbated if all depositors simultaneously try towithdraw their savings from the bank. This risk could be averted if lendersheld loan portfolios that were well diversified. But credit markets in rural areastend to be segmented, meaning that a lender's portfolio of loans is concentrated on a group of individuals facing common shocks to their incomes-in oneparticular geographic area, for example, or on farmers producing one particular crop, or on one particular kinship group.Segmented credit markets in the rural areas of developing countries oftendepend on informal credit, such as local moneylenders, friends and relatives,rotating savings, and credit associations. Informal credit institutions tend tooperate locally, using local information and enforcement mechanisms.The cost of segmentation is that funds fail to flow across regions or groupsof individuals even though there are potential gains from doing so, as whenneeds for credit differ across locations. For example, a flood may create a significant demand for loans to rebuild. But because credit institutions are localized, such flows may be limited. Deposit retention schemes, which require thatsome percentage of deposits raised be reinvested in the same region, or thepractice of unit banking may exacerbate the segmentation. Finding the optimalscope of financial intermediaries may require a tradeoff. Local lenders mayhave better information and may be more accountable to their depositors thanlarge, national lenders. However, the latter may have better access to well diversified loan portfolios.
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