How Do Market Failures Justify Interventions in Rural Credit Markets

Understanding of the economic causes and consequences of market failure in credit markets has progressed a great deal in recent years. This article draws on these developments to appraise the case for government intervention in rural financial markets in developing countries and to discover whether the theoretical findings can be used to identify directives for policy. Before debating the when and how of intervention, the article defines market failure, emphasizing the need to consider the full array of constraints that combine to make a market work imperfectly. The various reasons for market failure are discussed and set in the context in which credit markets function in developing countries. The article then looks at recurrent problems that may be cited as failures of the market justifying intervention. Among these problems are enforcement; imperfect information, especially adverse selection and moral hazard; the risk of bank runs; and the need for safeguards against the monopoly power of some lenders. The review concludes with a discussion of interventions, focusing on the learning process that must take place for financial markets to operate effectively.