Community Membership and Reciprocity in Lending: Evidence from Informal Markets
80 Pages Posted: 28 Jan 2021 Last revised: 30 Jun 2022
Date Written: June 29, 2022
We study how wholesalers assess credit risk and extend trade credit to retailers in informal economies where market institutions, such as financial reporting systems, auditing, and courts, are nonexistent or function poorly. Using the setting of a large market in India, we find that community membership plays a strong role in the access to credit. Wholesalers are more likely to provide trade credit and to offer less restrictive credit terms to within-community retailers, and are more lenient when these retailers default. Our findings suggest that an indirect reciprocity mechanism explains within-community credit flows, as evidenced by wholesalers with low endowments, those with greater within-community information flows about them, and those facing income shocks being more likely to provide preferential lending to their community retailers. The importance of the indirect reciprocity mechanism is further supported by evidence on the help traders receive from their community members following the COVID-19–related income shock.
Keywords: Trade Credit, Informal Economies, Lending, Reciprocity, India, Iewduh, Community Enforcement, Asymmetric Information
JEL Classification: D82, G21, G28, O10, O16, O17, Z10, Z13
Suggested Citation: Suggested Citation