Information and enforcement in informal credit markets (original) (raw)
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Competitive equilibrium in the credit market under asymmetric information
Journal of Economic Theory, 1987
We study. a competitive credit market equilibrium in which all agents are risk neutral and lenders a priori unaware of borrowers' default probabilities. Admissible credit contracts are characterized by the credit granting probability, the loan quantity, the loan interest rate and the collateral required. The principal result is that in equilibrium lower risk borrowers pay higher interest rates than higher risk borrowers; moreover, the lower risk borrowers get more credit in equilibrium than they would with full information. No credit is rationed and collateral requirements are higher for the lower risk borrowers.
Vertical Linkage between Formal and Informal Credit Markets
Emerging Issues in Economic Development, 2014
We develop a model of vertical linkage between the formal and informal credit markets which highlights the presence of corruption in the distribution of formal credit. The existing moneylender, the bank o¢cial and the new moneylenders move sequentially and the existing moneylender acts as a Stackelberg leader and unilaterally decides on the informal interest rate. The analysis distinguishes between two di¤erent ways of designing a credit subsidy policy. If a credit subsidy policy is undertaken through an increase in the supply of institutional credit, it is likely to increase the competitiveness in the informal credit market and lower the informal sector interest rate under reasonable parametric restrictions. Any change in the formal sector interest rate has no e¤ect. However, an anticorruption measure (increase in penalty) unambiguously lowers the interest rate in the informal credit market. Finally, we examine the e¤ects of alternative policies on the incomes of di¤erent economic agents in our model.
2011
applied areas of the social sciences, encompassing diverse aspects of development. ISEC works with central, state and local governments as well as international agencies by undertaking systematic studies of resource potential, identifying factors influencing growth and examining measures for reducing poverty. The thrust areas of research include state and local economic policies, issues relating to sociological and demographic transition, environmental issues and fiscal, administrative and political decentralization and governance. It pursues fruitful contacts with other institutions and scholars devoted to social science research through collaborative research programmes, seminars, etc.
Credit layering in informal financial markets
Journal of Development Economics, 2007
Informal lenders with access to markets or capital often find it attractive to delegate loan provision to downstream lenders who have an information or enforcement advantage in dealing with particular borrowers. In this paper we examine the conditions under which such an arrangement is preferred by two informal lenders, a landlord and a merchant, who compete in loan provision to tenant farmers differentiated by wealth. We show that credit layering is preferred only when tenants are sufficiently poor. In this case, the trader lends to tenant farmers via a contract with their landlord. Otherwise, only the trader lends. As a consequence, a pattern of borrowing emerges in which relatively wealthy tenants borrow from merchants while poor tenants borrow mainly from their landlords. Interlinkage between land and credit thus arises only for a subset of tenants and purely as a consequence of credit layering. This pattern is shown to be supported empirically.
Information and bank credit allocation
Journal of Financial Economics - J FINAN ECON, 2004
Private information obtained by lenders leads to borrower capture to the extent that such information cannot be communicated credibly to outsiders. We analyze how this capture affects the loan portfolio allocation of informed lenders. First, we show that banks charge higher interest rates and finance relatively less creditworthy borrowers in market segments with greater information asymmetries. Second, when faced with greater competition from outside lenders, banks reallocate credit toward more captured borrowers (flight to captivity). Third, if borrower quality and captivity are sufficiently correlated, an increase in the competitiveness of uninformed lenders can worsen the informed lender's overall loan portfolio. The model explains observed consequences of financial liberalizations.
Inequality, Informality, and Credit Market Imperfections
Macroeconomic Dynamics
This paper develops a microfounded macroeconomic modeling framework to investigate the relationship between informality and the income distribution. We show that multiple equilibria may rise if credit markets are imperfect and that there is a nondivisible entry cost in the formal economy. The theoretical analysis demonstrates that in the steady state, low levels of inequality are negatively correlated with high informality; conversely, high inequality exacerbates informality. This finding supports the hypothesis of an optimal level of inequality that minimizes the informal economy relative to the impact of other levels of inequality. However, for ordinary income distributions, changes in the level of inequality have only a slight effect on the informality rate. We calibrate the model using data on the U.S. and Mexican economies to estimate the level of inequality that minimizes the informality rate. The self-employment rate emerges as the most relevant determinant of the informality...
A Simple Model of Credit Rationing with Information Externalities: A General Equilibrium Approach
Credit-rationing model similar to Stiglitz and Weiss [1981] is combined with the information externality model of Lang and Nakamura [1993] to examine the properties of mortgage markets characterized by both adverse selection and information externalities. In a credit-rationing model, additional information increases lenders ability to distinguish risks, which leads to increased supply of credit. According to Lang and Nakamura, larger supply of credit leads to additional market activities and therefore, greater information. The combination of these two propositions leads to a general equilibrium model. This paper describes properties of this general equilibrium model. The paper provides another sufficient condition in which credit rationing falls with information. In that, external information improves the accuracy of equity-risk assessments of properties, which reduces credit rationing. Contrary to intuition, this increased accuracy raises the mortgage interest rate. This allows clarifying the trade offs associated with reduced credit rationing and the quality of applicant pool.
Group Lending and Endogenous Social Sanctions
2014
In recent years, microfinance institutions have expanded into group lending with individual liability, leaving out the joint liability clause which was an important feature in earlier lending contracts. Recent experimental evidence indicates that group lending may yield benefits, specifically lowering default rates, even in the absence of joint liability. In this paper, we develop a theoretical model where the public nature of group meetings means that borrowers have incentives to repay a group loan to safeguard their reputation. We show that the introduction of group loans with individual liability will cause sorting between joint liability and individual liability group loans. Specifically, borrowers who attach more importance to their reputation will select into individual liability loans, causing default rates and interest rates to rise for joint liability loans. The introduction of group loans with individual liability can even make joint liability loans infeasible in equilibrium.