Interactions of Informal and Formal Agents in South Asian Rural Credit Markets

Abstract

The paper provides a realistic explanation for the persistently large loan costs in the informal and formal credit markets of South Asia. In the presence of the adverse selection problems that arise from information asymmetries and discrepancies in credit services, price competition in somewhat differentiated products is sufficient to generate the high interest rate convergence observed in Nepalese credit markets. Most prior literature emphasizes collusion as the cause and leads to ineffective entry-oriented policy prescriptions. The new interpretation stresses the need to reduce information asymmetries, product differentiation, and moral hazard risks, while widening the spatial orbits of agent competition.