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Contractual Restrictions and Debt Traps

Author

Listed:
  • Ernest Liu
  • Benjamin N Roth

Abstract

Microcredit and other forms of small-scale finance have failed to catalyze entrepreneurship in developing countries. In these credit markets, borrowers and lenders often bargain over not only the interest rate but also implicit restrictions on types of investment. We build a dynamic model of informal lending and show this may lead to endogenous debt traps. Lenders constrain business growth for poor borrowers, yet richer borrowers may grow their businesses faster than they could have without credit. The theory offers nuanced comparative statics and rationalizes the low average impact and low demand of microfinance, despite its high impact on larger businesses.

Suggested Citation

  • Ernest Liu & Benjamin N Roth, 2022. "Contractual Restrictions and Debt Traps," The Review of Financial Studies, Society for Financial Studies, vol. 35(3), pages 1141-1182.
    • Handle: RePEc:oup:rfinst:v:35:y:2022:i:3:p:1141-1182.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhab054
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    Cited by:

    1. Dasgupta, Dyotona & Mookherjee, Dilip, 2023. "A theory of progressive lending," Games and Economic Behavior, Elsevier, vol. 137(C), pages 211-227.

    More about this item

    JEL classification:

    • D25 - Microeconomics - - Production and Organizations - - - Intertemporal Firm Choice: Investment, Capacity, and Financing
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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