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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 Department of Economics Working Papers with number 2007-06.

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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 (2010) Vol. 58, no. 4: 775-803.
Handle: RePEc:wil:wileco:2007-06

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

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  1. Manove, Michael & Padilla, A Jorge & Pagano, Marco, 2001. "Collateral versus Project Screening: A Model of Lazy Banks," RAND Journal of Economics, The RAND Corporation, vol. 32(4), pages 726-44, Winter.
  2. Manove, M. & Padilla, A.J. & Pagano, M., 1998. "Collateral vs. Project Screening: a Model of Lazy Banks," Papers, Centro de Estudios Monetarios Y Financieros- 9807, Centro de Estudios Monetarios Y Financieros-.
  3. Manove, Michael & Padilla, Atilano Jorge, 1998. "Banking (Conservatively) With Optimists," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1918, C.E.P.R. Discussion Papers.
  4. 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, Elsevier, vol. 58(1), pages 1-24, February.
  5. Carter, Michael R., 1988. "Equilibrium credit rationing of small farm agriculture," Journal of Development Economics, Elsevier, Elsevier, vol. 28(1), pages 83-103, February.
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