Bank-moneylender linkage as an alternative to bank competition in rural credit markets

Abstract:     
This paper proposes a new method in which banks and moneylenders can link in rural credit markets. Banks and moneylenders, two of the major lenders in rural credit markets, differ in their information on borrowers and costs of funds. Due to information constraints, banks must deny further loans to borrowers who cannot repay a certain amount. In the linkage, these borrowers obtain loans from moneylenders, repay the banks, and have continuing access. We then evaluate conditions under which the linkage would be preferred to bank competition and find that the linkage dominates for a wide range of parameters. In light of recent proposals to liberalize Indian banking, the analysis provides a cautionary note to the limits of introducing banking competition in rural credit markets and provides an alternative.

JEL Classification: E32; E52; O42

Accepted Paper Series