Question

What market inefficiency is being exploited by Grameen Bank? What is the source of this inefficiency?

Short answer

Grameen Bank exploits the inefficiency created when the lending market fails to offer loans to those who do not have settled credit history or assets to put up as collateral.

The risk of financial loss associated with these households (small income groups) is very high. So the market does not approve their loan,thereby leading to inefficiency.

Step-by-step solution

The reason behind the market inefficiency by regular banks

There are small income households that exist in large numbers in a country. These households are capable of making small savings. Many of them want small loans to finance business, health, marriage requirements, and many more.

Regular banks do not offer these households a loan because of their small savings and inability to offer any asset as collateral to them. Grameen Bank utilizes this inefficiency of the market. It borrowed savings from such households and decided to provide micro-lending to required households at small interest rates.

The source behind inefficiency occurred in the market

These small households do not provide an alternative to regular banks for covering the loss if a lender fails to repay the loan amount. Thus, the risk of financial loss (if they fail to repay) associated with these households is very high compared to those lenders who provide assets for collateral or maintain huge savings in their bank account.

Therefore, the regular banks hesitate to lend loans to these households. Hence, the source behind the inefficiency in the market is the high degree of risk associated with small households.