Formal versus Informal Credit: Which is Better in Helping Rural Areas in Vietnam?

Abstract

The study seeks to evaluate the impacts of three types of credit -formal, semi-formal, and informal credits -on the well-being of households in Vietnam's rural areas. Based on data from the Vietnam Household Living Standard Surveys in 2014 and 2016, the research uses the instrumental variable fixed-effect models to estimate the effects of three kinds of credit on household's per capita income and expenditure. There are some significant findings. First, in rural areas, formal credit is the most popular source with stable and cheap borrowing costs. Informal credit is a complement to formal credit to meet urgent needs. Funding agriculture activities is the most commonly cited purpose of borrowing, followed by purchasing assets. The highest misuse rate belongs to the group of loans for agriculture production. Second, the results show that credit helps smoothen consumption rather than generate income for rural households. Three types of credit have insignificant or negative effects on household's per capita income. Formal loans significantly improve total expenditure and spending on healthcare and education. Informal and semi-formal credits show a little influence on consumption. Informal loans have a significantly positive effect on healthcare expenditure. In contrast, having semi-formal loans tends to decrease spending on foods.

The interrelationships among the formal, semiformal and informal credit demands of farm households in Vietnam

“…In many developing countries, including Vietnam, the formal, semiformal and informal credit markets coexist (Linh et al, 2019;Truong et al, 2020 (Khoi and Gan, 2017;Truong et al, 2020). Semiformal credit providers do not operate under the credit institution law, including nongovernmental organizations, unlicensed MFIs and microfinance programs within mass organizations (e.g.…”

“…Female-headed farm households are more likely to demand semiformal credit, indicating that the semiformal credit sector supports the formal credit sector to increase credit Credit demands of farm households in Vietnam accessibility for disadvantaged groups of borrowers (such as women). However, the semiformal credit market is still small with limited coverage (Truong et al, 2020). This issue originates from both policy-related aspects (e.g.…”

“…Formal credit providers in Vietnam are regulated and supervised by the State Bank of Vietnam (central bank), and their credit activities are pursuant to the credit institution law. The source of formal credit refers to commercial banks, policy banks, cooperative banks, people's credit funds, and licensed microfinance institutions (MFIs) (Khoi and Gan, 2017;Truong et al, 2020). Semi-formal credit providers do not operate under the credit institution law, including non-governmental organizations, unlicensed MFIs, and microfinance programs within mass organizations (e.g., Farmers' Union or Women's Union) or development projects (Truong et al, 2020).…”

“…The source of formal credit refers to commercial banks, policy banks, cooperative banks, people's credit funds, and licensed microfinance institutions (MFIs) (Khoi and Gan, 2017;Truong et al, 2020). Semi-formal credit providers do not operate under the credit institution law, including non-governmental organizations, unlicensed MFIs, and microfinance programs within mass organizations (e.g., Farmers' Union or Women's Union) or development projects (Truong et al, 2020). Informal credit sector includes credit providers who are unlicensed and provide credit that is not regulated by the state but relies on social sanctions or personal relationships as means of enforcement.…”

“…small with limited coverage (Truong et al, 2020). This issue originates from both policy-related aspects (e.g., not able to access commercial funding) and the semi-formal credit providers themselves (limited human resources, technology, poor governance, etc.)…”