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Can an interest-free credit facility be more efficient than a usurious payday loan?

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  • Murizah Osman Salleh

    (Bank Negara Malaysia and Bangor University)

  • Aziz Jaafar

    (Bangor Business School)

  • M. Shahid Ebrahim

    ()
    (Bangor Business School)

Abstract

Permanent disequilibrium in mainstream credit markets have pushed the unbanked and underbanked households to frequent high cost payday loans for their liquidity needs. Associated with the latter are welfare-reducing issues of predation and debt-entrapment. In response to this market failure, we expound a simple model that integrates inexpensive interest-free liquidity facility within an endogenous leverage circuit. This builds on the technology of ROSCA/ ASCRA/ mutual/ financial cooperative and cultural beliefs indoctrinated in Islam. Results indicate that such a circuit moderates adverse selection and moral hazard issues more efficiently than payday loan and mainstream financier. Additionally, it does not suffer the drawbacks of welfare-reducing payday loans and also addresses financial exclusion in mainstream credit markets.

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Bibliographic Info

Paper provided by Bangor Business School, Prifysgol Bangor University (Cymru / Wales) in its series Working Papers with number 12008.

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Date of creation: Jul 2012
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Handle: RePEc:bng:wpaper:12008

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Keywords: interest-free loan; payday loan; financial exclusion; liquidity facility; cooperatives;

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