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Only Twice As Much: A Rule for Regulating Lenders

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Abstract

Present-day policies aiming to improve the performance of credit markets, such as group-lending or creation of collateral, typically aim to change incentives for borrowers. In contrast, pre-modern credit market interventions, such as usury laws, often targeted the behavior of lenders. We describe and model a norm which, though widespread, has escaped scholarly attention: a stipulation that accumulated interest cannot exceed the original principal, irrespective of how much time has elapsed. We interpret this rule, which is found in Hindu, Roman, and Chinese legal traditions, as giving lenders the incentive to find more capable borrowers, who will be able to repay early, thereby improving the allocation of capital. We document the consistency between our explanation and the rationale offered by policy-makers.

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Paper provided by Department of Economics, Williams College in its series Center for Development Economics with number 2007-03.

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Length: 32 pages
Date of creation: Jan 2007
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Publication status: Published in Economic Development and Cultural Change, July 2010, v. 58, iss. 4, pp. 775-803.
Handle: RePEc:wil:wilcde:2007-03

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Keywords: Rural Credit Markets; Information Acquisition; Predatory Lending;

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  1. Kranton, Rachel E. & Swamy, Anand V., 1999. "The hazards of piecemeal reform: british civil courts and the credit market in colonial India," Journal of Development Economics, Elsevier, vol. 58(1), pages 1-24, February.
  2. Michael Manove & A. Jorge Padilla & Marco Pagano, 1998. "Collateral vs. Project Screening: A Model of Lazy Banks," CSEF Working Papers 10, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  3. Carter, Michael R., 1988. "Equilibrium credit rationing of small farm agriculture," Journal of Development Economics, Elsevier, vol. 28(1), pages 83-103, February.
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