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Interactions Between Two Informal Sector Lenders And Interest Rate Determination In The Informal Credit Market: A Theoretical Analysis

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  • Sarbajit Chaudhuri

Abstract

The paper provides a theory of interest rates determination in the informal credit market in backward agriculture highlighting the interactions between two informal sector lenders (a professional moneylender and a trader-interlocker) and explains the prevalence of different interest rates in the rural credit market. The trader and the moneylender play a non-cooperative game in choosing the extent of interlinkage and the non-interlinked informal interest rate, respectively. In the interlinked credit-product contract, the trader offers the interlockees a product price equal to the open market price and his entire surplus comes from his activities in the credit market. These results are completely opposite to those found in the existing literature on interlinkage. A price subsidy policy reduces the extent of interlinkage chosen by the trader while a credit subsidy policy may raise it. Besides, the subsidy policies unequivocally raise the non- interlinked informal interest rate of the moneylender but may lower the welfare of the farmers and the agricultural productivity. In this context, an alternative credit policy of forging a vertical linkage between the formal and informal credit markets has been considered. It has been found that a credit subsidy policy under the new system is able to raise the agricultural productivity and improve the welfare of the farmers by ameliorating their borrowing terms in the credit market.

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File URL: http://128.118.178.162/eps/game/papers/0511/0511002.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Game Theory and Information with number 0511002.

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Length: 26 pages
Date of creation: 09 Nov 2005
Date of revision:
Handle: RePEc:wpa:wuwpga:0511002

Note: Type of Document - pdf; pages: 26
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Web page: http://128.118.178.162

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Keywords: Trader; Moneylender; Formal credit; Informal credit; Interlinkage; Interest rate; Nash equilibrium; Subsidy policy; Vertical linkage;

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  1. Chaudhuri, Sarbajit & Gupta, Manash Ranjan, 1996. "Delayed formal credit, bribing and the informal credit market in agriculture: A theoretical analysis," Journal of Development Economics, Elsevier, vol. 51(2), pages 433-449, December.
  2. Floro, Maria Sagrario & Ray, Debraj, 1997. "Vertical Links between Formal and Informal Financial Institutions," Review of Development Economics, Wiley Blackwell, vol. 1(1), pages 34-56, February.
  3. Gangopadhyay, Shubhashis & Sengupta, Kunal, 1987. "Small Farmers, Moneylenders and Trading Activity," Oxford Economic Papers, Oxford University Press, vol. 39(2), pages 333-42, June.
  4. Hoff, Karla & Stiglitz, Joseph E., 1998. "Moneylenders and bankers: price-increasing subsidies in a monopolistically competitive market," Journal of Development Economics, Elsevier, vol. 55(2), pages 485-518, April.
  5. Chaudhuri, Sarbajit & Ghosh Dastidar, Krishnendu, 2011. "Vertical linkage between formal and informal credit markets: corruption and credit subsidy policy," MPRA Paper 35563, University Library of Munich, Germany.
  6. Gupta, Manash Ranjan & Chaudhuri, Sarbajit, 1997. "Formal Credit, Corruption and the Informal Credit Market in Agriculture: A Theoretical Analysis," Economica, London School of Economics and Political Science, vol. 64(254), pages 331-43, May.
  7. Kaushik Basu, 2003. "Analytical Development Economics: The Less Developed Economy Revisited," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262523442, December.
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Cited by:
  1. Chaudhuri, Sarbajit & Gupta, Manash Ranjan, 2011. "International factor mobility, informal interest rate and capital market imperfection: a general equilibrium analysis," MPRA Paper 32682, University Library of Munich, Germany.

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