Advanced Search
MyIDEAS: Login

A Friend in Need is a Friend Indeed: Theory and Evidence on the (Dis)Advantages of Informal Loans

Contents:

Author Info

Abstract

We develop a model to study the choice between formal and informal sources of credit in a setting with strategic default due to limited enforcement. Informal loans (e.g., from friends or relatives) are enforced by the threat of both parties losing the friendship relation. In contrast, formal loans (e.g., from banks) can only be enforced via collateral requirement. We show that the optimal informal loan contract features zero interest rate and zero physical collateral requirement. In contrast, formal loans always charge positive interest and require collateral. Borrowers are more likely to choose informal loans for small investment needs, and for loans with no or low default risk. Riskier loans, up to a limit, are optimally taken from formal sources since physical collateral, unlike social collateral is divisible, and defaulting with a bank is thus less costly than defaulting with a friend. Very risky loans, in contrast, can only be financed by informal sources due to insufficient collateral. Because default with social capital is relatively costly, however, personal loans also imply a limited growth potential. Empirical results from a cross section of 2880 Thai households are consistent with the predicted pattern of formal versus informal credit.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.sfu.ca/econ-research/RePEc/sfu/sfudps/dp13-03.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Department of Economics, Simon Fraser University in its series Discussion Papers with number dp13-03.

as in new window
Length: 33
Date of creation: May 2013
Date of revision: Apr 2013
Handle: RePEc:sfu:sfudps:dp13-03

Contact details of provider:
Postal: Department of Economics, Simon Fraser University, 8888 University Drive, Burnaby, BC, V5A 1S6, Canada
Phone: (778)782-3508
Fax: (778)782-5944
Web page: http://www.sfu.ca/economics.html
More information through EDIRC

Order Information:
Postal: Working Paper Coordinator, Department of Economics, Simon Fraser University, 8888 University Drive, Burnaby, BC, V5A 1S6, Canada
Email:
Web: http://www.sfu.ca/economics/research/publications.html

Related research

Keywords: Informal credit; family loans; social capital; peer-to-peer lending; microfinance.;

Find related papers by JEL classification:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  2. Kochar, Anjini, 1997. "An empirical investigation of rationing constraints in rural credit markets in India," Journal of Development Economics, Elsevier, vol. 53(2), pages 339-371, August.
  3. Mansuri, Ghazala, 2007. "Credit layering in informal financial markets," Journal of Development Economics, Elsevier, vol. 84(2), pages 715-730, November.
  4. Braverman, Avishay & Stiglitz, Joseph E, 1982. "Sharecropping and the Interlinking of Agrarian Markets," American Economic Review, American Economic Association, vol. 72(4), pages 695-715, September.
  5. Timothy Besley, 1995. "Nonmarket Institutions for Credit and Risk Sharing in Low-Income Countries," Journal of Economic Perspectives, American Economic Association, vol. 9(3), pages 115-127, Summer.
  6. Bose, Pinaki, 1998. "Formal-informal sector interaction in rural credit markets," Journal of Development Economics, Elsevier, vol. 56(2), pages 265-280, August.
  7. Mikkel Barslund & Finn Tarp, 2007. "Formal and Informal Rural Credit in Four Provinces of Vietnam," Discussion Papers 07-07, University of Copenhagen. Department of Economics.
  8. Ghatak, Maitreesh, 1999. "Group lending, local information and peer selection," Journal of Development Economics, Elsevier, vol. 60(1), pages 27-50, October.
  9. Stephen R. Boucher & Michael R. Carter & Catherine Guirkinger, 2008. "Risk Rationing and Wealth Effects in Credit Markets: Theory and Implications for Agricultural Development," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 90(2), pages 409-423.
  10. Turvey, Calum G. & Kong, Rong, 2010. "Informal lending amongst friends and relatives: Can microcredit compete in rural China?," China Economic Review, Elsevier, vol. 21(4), pages 544-556, December.
  11. Besley, Timothy & Coate, Stephen, 1995. "Group lending, repayment incentives and social collateral," Journal of Development Economics, Elsevier, vol. 46(1), pages 1-18, February.
  12. Jain, Sanjay, 1999. "Symbiosis vs. crowding-out: the interaction of formal and informal credit markets in developing countries," Journal of Development Economics, Elsevier, vol. 59(2), pages 419-444, August.
  13. Abhijit V. Banerjee & Esther Duflo, 2007. "The Economic Lives of the Poor," Journal of Economic Perspectives, American Economic Association, vol. 21(1), pages 141-168, Winter.
  14. Giné, Xavier, 2011. "Access to capital in rural Thailand: An estimated model of formal vs. informal credit," Journal of Development Economics, Elsevier, vol. 96(1), pages 16-29, September.
  15. Townsend, Robert M, 1995. "Financial Systems in Northern Thai Villages," The Quarterly Journal of Economics, MIT Press, vol. 110(4), pages 1011-46, November.
Full references (including those not matched with items on IDEAS)

Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. When to borrow from friends
    by Economic Logician in Economic Logic on 2013-08-12 15:09:00
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Kislat, Carmen & Menkhoff, Lukas & Neuberger, Doris, 2013. "The use of collateral in formal and informal lending," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79765, Verein für Socialpolitik / German Economic Association.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:sfu:sfudps:dp13-03. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Working Paper Coordinator).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.