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Informal Credit in Village Economies: Contract Duration with Personal and Community Enforcement

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  • Loren Brandt

    (University of Toronto)

  • Arthur Hosios

    (University of Toronto)

Abstract

This paper provides an explanation for several important features of informal credit contracts negotiated in economies where households lack collateral, and ready access to legal authorities and formal financial institutions is absent. Our analysis highlights the choice between loans with well-defined repayment periods (fixed durations) and those that are open-ended (no duration). We argue that households negotiate fixed- duration loans only when the borrower's ability to repay is private information, and borrowers enjoy non-credit (social) exchanges with lenders that can be withdrawn to encourage loan repayment. Other differences in loan terms can be explained by the exclusive availability of collective loan enforcement to lenders and borrowers residing in the same community. Drawing on a unique household-level survey, we find empirical support for our model's explanation for duration and the size of loans, as well as borrower's repayment behavior. Our analysis also highlights a negative externality among informal personal and community enforcement mechanisms whereby the availability of both mechanisms in the same village reduces the payments that can be credibly promised with either one.

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Bibliographic Info

Paper provided by EconWPA in its series Law and Economics with number 0410001.

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Length: 60 pages
Date of creation: 04 Oct 2004
Date of revision:
Handle: RePEc:wpa:wuwple:0410001

Note: Type of Document - pdf; pages: 60
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  1. Michi Kandori, 2010. "Social Norms and Community Enforcement," Levine's Working Paper Archive 630, David K. Levine.
  2. Greif, Avner, 1994. "Cultural Beliefs and the Organization of Society: A Historical and Theoretical Reflection on Collectivist and Individualist Societies," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 102(5), pages 912-50, October.
  3. Marcel Fafchamps & Susan Lund, . "Risk Sharing Networks in Rural Philippines," Working Papers, Stanford University, Department of Economics 97014, Stanford University, Department of Economics.
  4. Bulow, Jeremy & Rogoff, Kenneth S., 1989. "A Constant Recontracting Model of Sovereign Debt," Scholarly Articles 12491028, Harvard University Department of Economics.
  5. John McMillan & Christopher Woodruff, 1999. "Interfirm Relationships And Informal Credit In Vietnam," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 114(4), pages 1285-1320, November.
  6. Udry, Christopher, 1990. "Credit Markets in Northern Nigeria: Credit as Insurance in a Rural Economy," World Bank Economic Review, World Bank Group, World Bank Group, vol. 4(3), pages 251-69, September.
  7. Townsend, Robert M, 1995. "Financial Systems in Northern Thai Villages," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 110(4), pages 1011-46, November.
  8. Ligon, Ethan & Thomas, Jonathan P & Worrall, Tim, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," Review of Economic Studies, Wiley Blackwell, vol. 69(1), pages 209-44, January.
  9. Greif, Avner, 1993. "Contract Enforceability and Economic Institutions in Early Trade: the Maghribi Traders' Coalition," American Economic Review, American Economic Association, vol. 83(3), pages 525-48, June.
  10. Udry, Christopher, 1994. "Risk and Insurance in a Rural Credit Market: An Empirical Investigation in Northern Nigeria," Review of Economic Studies, Wiley Blackwell, vol. 61(3), pages 495-526, July.
  11. Besley, T., 1993. "Savings, Credit and Insurance," Papers 167, Princeton, Woodrow Wilson School - Development Studies.
  12. Jonathan Levin, 2002. "Multilateral Contracting And The Employment Relationship," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 117(3), pages 1075-1103, August.
  13. Harold L. Cole & Patrick J. Kehoe, 1996. "Reputation spillover across relationships: reviving reputation models of debt," Staff Report, Federal Reserve Bank of Minneapolis 209, Federal Reserve Bank of Minneapolis.
  14. Fafchamps, Marcel, 1992. "Solidarity Networks in Preindustrial Societies: Rational Peasants with a Moral Economy," Economic Development and Cultural Change, University of Chicago Press, vol. 41(1), pages 147-74, October.
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