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Social capital and credit constraints in informal finance

Author

Listed:
  • Liu, Wei

    (United Nations)

  • Spanjers, Willem

    (Kingston University London)

Abstract

This paper considers problems arising from contract enforcement and the atten- dant possibility of voluntary default. Loan contracts in the informal sector are rarely explicitly recorded and enforced by formal legal institutions. Repayments may be induced via informal enforcement mechanisms based on social sanctions through linked relations in repeated inter- actions. Lenders tend to use the strength these (bilateral) relations, called social capital, as a device for rationing heterogeneous borrowers. We apply the existing notion of exogenous social capital and introduce the notion of endogenous social capital. Appropriates level of social capital may promote loans that otherwise would not be granted. For small loans though, the endogenous social capital may become negative. We find that in such cases borrowers may be encouraged to take up excessive loans to increase incentives for repaying. The theoretical analysis is supported by empirical observations, mainly from China.

Suggested Citation

  • Liu, Wei & Spanjers, Willem, 2005. "Social capital and credit constraints in informal finance," Economics Discussion Papers 2005-5, School of Economics, Kingston University London.
    • Handle: RePEc:ris:kngedp:2005_005
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    More about this item

    Keywords

    Self-enforcing Contract; Social Capital; Credit Constraints; Informal Credit;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • 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

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