ASYMMETRIC

INFORMATION IN
RURAL CREDIT
MARKET:
James Gichuki

Outline

Background/Introduction

Modus Operandi of Rural Credit Markets

Theoretical Foundations

Empirical Evidence in Developing Countries

Credit Markets in Northern Nigeria
South African Low-Income Housing Market
Rural Credit Market in Pakistan
Informal Credit Agencies in Rural India

Efficiency & Equity Issues

Conclusions

Background/Introduction

Rural credit markets have been at the center of

policy intervention in developing countries over the

past forty years supported by

Governments,

multilateral and bilateral aid agencies, and

Nongovernmental Organizations
The results of many of these interventions
been disappointing.

have

Background/Introduction ctd

In spite of high levels of subsidy to rural credit in

developing countries, many rural farmer-holders
still depend on rural moneylenders.

Interest rates for credit in rural areas still remains

extremely high

These features of credit markets can be

understood in the context of missing (Stiglitz and
Hoff, 1990)
Samuel Addo & Nobuhle Maphosa

How does this problem become an

information problem?

Borrowers differ in the likelihood that they will

default, making it costly to determine the risk type
of each borrower (screening problem).

It is costly to ensure that borrowers take those

actions which make repayment most likely; moral
hazard/incentives problem.

It is difficult to compel repayment; the enforcement

problem.
Samuel Addo & Nobuhle Maphosa

Relationship between the formal and informal sectors

of rural credit markets

Modus Operandi of Rural Credit Markets

In order to serve this section of the masses several

products arise;
usufruct loans,
kinship- and village-based credit systems,
Trade-credit interlinkages, and
rotating savings and credit associations.

Theoretical Foundations
Akerlof 1970 The Market for Lemons

Credit markets in underdeveloped countries often strongly reflect the

operation of the Lemons Principle.
Workings of the Lemons Principle concerns the extortionate rates which
the local moneylender charges his clients.

Theoretical Foundations

Stiglitz and Weiss 1981

Interest rate as a Screening Device
Incentive Mechanism
The Theory of Collaterally and Limited

Liability
Observationally Distinguishable Borrowers

Theoretical Foundations

Hoff K. (1996) Market failure and

distortion of Worth
Wealth effects in a credit market
Wealth effect on the organization of work
Wealth effects in Agency relationships with

moral hazard

Samuel Addo & Nobuhle Maphosa

Theoretical Foundations

Hoff and Stiglitz (1990) Imperfect

information and rural credit market
Stiglitz and Weiss (1992)
asymmetric information in credit
market

Samuel Addo & Nobuhle Maphosa

Empirical Evidence in Developing Countries

Thailand (Saimwala etal )

govt tried saving the farmer from the grip of the rural money lender

and failed.
Money lender is not an institution its a man/wife or durable good
lender.
Could be 5 lenders in a village 3 local, two outside traders
42% were not served- low income who would not go to the bank coz
they were sure to be turned down, or never needed debts
Rural lender has complete infor about borrower, can monitor his
activities, and be updated. The decision is joint rather than just
business.
a policy of allocating 10 percent of bank deposits to the rural
sector would lower agricultural product prices by 1.04 percent,
increase per capita real income in rural areas by only 0.3 percent
(per capita real urban income increased by 1.3 percent), and
increase the Gini coefficient of rural incomes from 0.575 very
marginally to 0.578.

Samuel Addo & Nobuhle Maphosa

Empirical Evidence in Developing

Countries

Nigeria (Udry, 1990) n=198 Kaduna state,

kinship type
Loans were done in the forms of interpersonal, group

financial schemes, rotating credit, saving

associations or joint liability microfinance among
others.
90% of households engaged in it with only 7.5%
commercial mainly from tobacco company.
Formal lenders almost completely absent in the
area. 97% loans between residents or relatives.
Repayment periods were not explicitly stated nor
interest rates stated but averaged <3months.
Small close knit society ensured lender knew
borrower well. 82/808 could account for unexpected
occurrences in transaction with partners
Muslim clerics adjudicate disputes with serious
social sanctions to offender.

Information asymmetries between lender and

borrower forgotten with their institutional
consequences- collateral, interlinked contracts.
Formal institutions could exploit the free flow
of information to design peer monitoring to
support lending under sharia banking.

Samuel Addo & Nobuhle Maphosa

Empirical Evidence in Developing Countries

India (Clive, 1990)

State attempt to register rural moneylenders made

them operate underground but not end.

Fierce challenge by cooperatives and commercial
banks
Money lenders had intimate knowledge of
borrowers character and their circumstances.
Preferred to deal with long standing clients making
it hard for borrowers to switch over.
Trader moneylender enforced contract by ensuring
he was the buyer of crop and he recovered loan
from this crop.

Samuel Addo & Nobuhle Maphosa

Efficiency & Equity

Issues..1

Information asymmetry and its slow resolution has

ensured that some people have more than enough
to put their skills to best use while others cant
even access credit.
Wealth in the form of collateral plays a calytic
effect more than inputs
Wealth distribution effects affect market decisions
of individuals by influencing macrovariables like
wages and prices so that welfare of any single
agent depends on entire distribution of wealth.
These distribution effects now will be passed down
the next term and eventually generations
Samuel Addo & Nobuhle Maphosa

Efficiency & Equity Issues2

Highly concentrated wealth may refuse a

large section of individuals an opportunity
to be productive.
Low wealth individuals may be shut out of
capital markets labor contracts and land
rental contracts.
The poor are unable to invest in human
capital or to be self employed.
Research has showed that having an initial
endowment (bequests) of increases the
likelihood of being entrepreneur.
Samuel Addo & Nobuhle Maphosa

Policy implications and conclusion

The existence of this information

problem and the refusal of the rural
money lender to let go has lead to a
mix of interventions;
Collateral being required
Vetting borrower before granting loans
Trade credit interlinkages
Spot transactions
Depositing of title deed with the lender.
Peer monitoring

What are the policy responses?

Monetary policy fails in responding to rurAL

credit market because it does not respond to
interest rates from central bank.
Government must be more deliberate in
targeting poor masses in rural areas seeing that
lending to the rich raises interest rates
worsening the problem.
Reduce information costs by developing
alternative markets. Titling land, commercializing
goods mkt, improving rural infrastructure,
among others to decrease distortions.
Samuel Addo & Nobuhle Maphosa

References

Udry, C. (1990). Credit markets in Northern

Nigeria: Credit as insurance in a rural economy.
The World Bank Economic Review, 4(3), 251-269.
Bell, C. (1990). Interactions between institutional
and informal credit agencies in rural India. The
World Bank Economic Review, 4(3), 297-327.
Ebert, L. (2001). Asymmetric Information and
Fragility in the South African Low-Income Housing
Market. Journal of Economic Development, 26(2),
91-106.

Samuel Addo & Nobuhle Maphosa