Information and Enforcement in Informal Credit Markets." mimeo

ABSTRACT. We study the problem of loan enforcement in an informal credit market with limited information flow. Specifically, credit histories of borrowers are not available, raising the possibility of endemic default. We show that if there is some minimum proportion of “natural defaulters ” in the population, then there exists an equilibrium characterized by certain simple behavior rules for lenders and borrowers. The equilibrium is unique if certain restrictions are placed on strategies. This equilibrium takes the form that lenders must advance a “small ” amount of credit (possibly at a high interest rate) to first-time borrowers. Credit limits are relaxed and the relationship is con-tinued, conditional on repayment. We call this phenomenon micro-rationing. We then introduce the possibility of macro-rationing: the temporary exclusion of some borrowers from any source of credit. We show that in this case, (i) our “simple ” equilibrium always exists regardless of the pro-portion of natural defaulters; though (ii) micro-rationing is always present in equilibrium, while (iii) macro-rationing arises if and only if the proportion of natural defaulters lies below a certain thresh-old. Finally, we show that if lenders have the option of privately collecting information on the credit histories of new clients, multiple equilibria in information collection could arise. Consequently, it is possible to interpret limited client information in informal credit markets as coordination failure among moneylenders. 1