Interactions of Informal and Formal Agents in South Asian Rural Credit Markets

Abstract

The paper provides a realistic explanation for the persistently large loan costs in the informal and formal credit markets of South Asia. In the presence of the adverse selection problems that arise from information asymmetries and discrepancies in credit services, price competition in somewhat differentiated products is sufficient to generate the high interest rate convergence observed in Nepalese credit markets. Most prior literature emphasizes collusion as the cause and leads to ineffective entry-oriented policy prescriptions. The new interpretation stresses the need to reduce information asymmetries, product differentiation, and moral hazard risks, while widening the spatial orbits of agent competition.

Immiserizing Credit: Challenging the Efficacy of Microfinance

“…Each period, households have the opportunity to augment either consumption or capital (or both) by borrowing, t . The source of funds may be formal or informal [1]. For simplification, we assume that borrowed funds are immediately and costlessly converted into the capital-consumption good.…”

“…Microfinance is a wider notion that includes savings options and sometimes crop, livestock, or credit insurance schemes. The goals of these programs are multiple and overlapping (Adams, Brunner & Raymond [1]). Three of the most relevant goals are: 1) To raise personal, family, community, and national product;…”

“…It is our intention here to lay out the beginnings of a model of a peasant household that can serve to answer a simple but fundamental query: What are the conditions under which a rational borrower will accept credit and be able to apply it to a farm or business opportunity that will enable timely repayment and lay a foundation for a ratcheting upwards of family incomes, with a presumption of an overall social benefit? We have chosen to title the paper, "Immiserizing Credit", because we believe that these conditions are stringent, the bar is high, and the outcomes are often enough painful 1 . After all, if one begins with a family operating at the margin of subsistence, and then begins an attempt to uplift them economically and socially by putting them into debt, then the logical chain of events must be firmly reasoned and the outcomes statistically very likely; otherwise, the indebted clients will be worse off after two, three, or four rounds of annual cycles than they were at the beginning.…”

Capacity‐constrained Collusive Price Discrimination in the Informal Rural Credit Markets of Nepal

“…Aleem (1990) explained the high interest rates by screening costs. Adams et al. (2003) refer to Nepalese credit markets and what they term as recent literature that attempts to explain the high interest rates by tacit collusion 2 .…”

The Geography of the Banking System, Migration, Remittances and Financial Inclusion: Evidence from Indonesia

“…In developing countries, it is well known that informal sectors also heavily shape how economies work at the local level. Of potential relevance here in terms of engagement with formal banking is the fact that in areas with limited access to formal finance, and especially in rural regions, the challenges associated with engagement with formal banking institutions may be partially offset by the existence of informal finance, alongside formal financial markets (Bell 1990;Kapur 1992;Bell et al 1997;Adams et al 2003). In many countries, RoSCAs are one of the most important types of informal financial institutions, building on local social capital and serving as an informal peer-to-peer banking institution.…”