The Effect of Moral Hazard on the Credit Risk in the Microfinance Sector; A Theoretical Approach

Abstract

Credit risk is a major concern in the banking and nance sector and has been one of the reasons for credit market imperfections across the globe. Moral hazard in credit markets, causes a major impact and a ects the determination of interest rates in the banking sector. This study set out to ascertain the probability of defaults of unsecured assets and secured assets. The study calculates the probability of occurrence of the behavior of borrowers and nd moral hazard e ects on individual credit risk system. Essentially, the study sought to nd how micro nance institutions are a ected when customers default on their payments. The study assessed the risk associated with micro nance business when the asset follows the Ornstein- Uhlenbeck process. Due to the fact that risks cannot be assessed using numerical data because we are dealing with human behaviors, we assumed that they invest their money in secured and unsecured assets. The study found that the impact of credit default was lesser with secured assets than it was with the unsecured assets and therefore recommend that micro nance institutions give credits with collateral more than the ones without collateral.