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

Author

Listed:
  • 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ability to repay is private information, and borrowers enjoy non-credit (social) exchanges with lenders that can be withdrawn to encourage loan repayment.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.

Suggested Citation

  • Loren Brandt & Arthur Hosios, 2004. "Informal Credit in Village Economies: Contract Duration with Personal and Community Enforcement," Law and Economics 0410001, EconWPA.
  • Handle: RePEc:wpa:wuwple:0410001
    Note: Type of Document - pdf; pages: 60
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    References listed on IDEAS

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    1. John McMillan & Christopher Woodruff, 1999. "Interfirm Relationships and Informal Credit in Vietnam," The Quarterly Journal of Economics, Oxford University Press, vol. 114(4), pages 1285-1320.
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    7. Harold L. Cole & Patrick J. Kehoe, 1996. "Reputation spillover across relationships: reviving reputation models of debt," Staff Report 209, Federal Reserve Bank of Minneapolis.
    8. Besley, Timothy, 1995. "Savings, credit and insurance," Handbook of Development Economics,in: Hollis Chenery & T.N. Srinivasan (ed.), Handbook of Development Economics, edition 1, volume 3, chapter 36, pages 2123-2207 Elsevier.
    9. 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, vol. 102(5), pages 912-950, October.
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    11. 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 147-174, October.
    12. Udry, Christopher, 1990. "Credit Markets in Northern Nigeria: Credit as Insurance in a Rural Economy," World Bank Economic Review, World Bank Group, vol. 4(3), pages 251-269, September.
    13. Michihiro Kandori, 1992. "Social Norms and Community Enforcement," Review of Economic Studies, Oxford University Press, vol. 59(1), pages 63-80.
    14. Robert M. Townsend, 1995. "Financial Systems in Northern Thai Villages," The Quarterly Journal of Economics, Oxford University Press, vol. 110(4), pages 1011-1046.
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