Changes in Social Network Structure in Response to Exposure to Formal Credit Markets

Abstract

We show that the entry of formal financial institutions can have far-reaching and long-lasting impacts on informal lending and social networks more generally. We first study the introduction of microfinance in 75 villages in Karnataka, India, 43 of which were exposed to microfinance. Using difference-in-differences, we show that networks shrank more in exposed villages. Moreover, links between households that were both unlikely to borrow from microfinance were at least as likely to disappear as links involving likely borrowers. We replicate these surprising findings in the context of a RCT in Hyderabad, where a microfinance institution randomly selected 52 of 104 neighborhoods to enter first. Four years after all neighborhoods were treated, households in early-entry neighborhoods had had credit access longer and had larger loans. We again find fewer social relationships between households in these neighborhoods, even among those ex-ante unlikely to borrow. Because the results suggest global spillovers, atypical in usual models of network formation, we develop a new dynamic model of network formation that emphasizes chance meetings, where efforts to socialize generate a global network-level externality. Finally, we analyze informal borrowing and the sensitivity of consumption to income fluctuations. Households unlikely to take up microcredit suffer the greatest loss of informal borrowing and risk sharing, underscoring the global nature of the externality.

Keywords: Social Networks, Network Change, Network Formation, Network Evolution, Microfinance, Market Exposure, Favor Exchange, Social Capital

JEL Classification: D85, D13, L14, O12, Z13