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Informal Finance: A Theory of Moneylenders

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  • Andreas Madestam

    (Bocconi University)

Abstract

I study the coexistence of formal and informal finance in underdeveloped credit markets. While weak institutions constrain formal banks, shallow pockets hamper informal lenders. In such economies, informal finance has two effects. By increasing the investment return it decreases borrowers’ relative payoff following default, inducing banks to lend more liberally (disciplinary effect). By channeling bank capital it reduces banks’ agency costs from lending directly to borrowers, limiting banks’ extension of borrower credit (rent-extraction effect). Among other things, the model shows that informal interest rates are higher, borrower welfare lower, and informal finance more prevalent when the rent-extraction effect prevails, consistent with stylized facts in poor societies.

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  • Andreas Madestam, 2009. "Informal Finance: A Theory of Moneylenders," Working Papers 2009.69, Fondazione Eni Enrico Mattei.
  • Handle: RePEc:fem:femwpa:2009.69
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    Cited by:

    1. Ghosh, Saibal & Kumar, Rakesh, 2014. "Monetary policy and informal finance: Is there a pecking order?," MPRA Paper 65243, University Library of Munich, Germany.
    2. Nicoletta Batini & Young-Bae Kim & Paul Levine & Emanuela Lotti, 2009. "Informal Labour and Credit Markets: A Survey," School of Economics Discussion Papers 0609, School of Economics, University of Surrey.
    3. Elmas Yaldız Hanedar & Yener Altunbas & Flavio Bazzana, 2014. "Why Do SMEs Use Informal Credit? A Comparison between Countries," Journal of Financial Management, Markets and Institutions, Società editrice il Mulino, issue 1, pages 65-86, July.
    4. Edwin Arbey Hernández García & Andrés Felipe Oviedo Gómez, 2016. "Mercado del crédito informal en Colombia: una aproximación empírica," ENSAYOS DE ECONOMÍA 015539, UNIVERSIDAD NACIONAL DE COLOMBIA SEDE MEDELLIN.
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    7. Erhardt, Eva Christine, 2017. "Microfinance beyond self-employment: Evidence for firms in Bulgaria," Labour Economics, Elsevier, vol. 47(C), pages 75-95.
    8. Migheli, Matteo, 2016. "Land Ownership, Access to Informal Credit and Its Cost in Rural Vietnam," Department of Economics and Statistics Cognetti de Martiis. Working Papers 201619, University of Turin.
    9. Athar Iqbal & Bilal Hamid, 2012. "Retail Business Owners Preference: Why not Formal Financing?," South Asian Journal of Management Sciences (SAJMS), Iqra University, Iqra University, vol. 6(1), pages 18-22, Spring.
    10. Cao Thi Khanh Nguyet, 2014. "Why do Small and Medium Enterprises Need to Access Informal Credit? The Case of Vietnam," International Finance and Banking, Macrothink Institute, vol. 1(2), pages 1-17, December.
    11. Raccanello, Kristiano, 2016. "Do Microenterprises’ size and status matter to access informal finance?./ ¿El tamaño y el registro de las microempresas permite el acceso a los mercados financieros informales?," Panorama Económico, Escuela Superior de Economía, Instituto Politécnico Nacional, vol. 12(23), pages 123-152, Segundo s.
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    14. Togba, Edith Leadaut, 2012. "Microfinance and households access to credit: Evidence from Côte d’Ivoire," Structural Change and Economic Dynamics, Elsevier, vol. 23(4), pages 473-486.
    15. Qin, Duo & Xu, Zhong & Zhang, Xuechun, 2014. "How much informal credit lending responded to monetary policy in China? The case of Wenzhou," Journal of Asian Economics, Elsevier, vol. 31, pages 22-31.
    16. Duo Qin & Zhong Xu & Xue-Chun Zhang, 2013. "How Much Has Private Credit Lending Reacted to Monetary Policy in China? The Case of Wenzhou," Working Papers 178, Department of Economics, SOAS, University of London, UK.
    17. Degryse, Hans & Lu, Liping & Ongena, Steven, 2016. "Informal or formal financing? Evidence on the co-funding of Chinese firms," Journal of Financial Intermediation, Elsevier, vol. 27(C), pages 31-50.
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    19. Leon, Florian, 2015. "Does bank competition alleviate credit constraints in developing countries?," Journal of Banking & Finance, Elsevier, vol. 57(C), pages 130-142.

    More about this item

    Keywords

    Credit Markets; Financial Development; Institutions; Market Structure;

    JEL classification:

    • O12 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Microeconomic Analyses of Economic Development
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General

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