Imperfect Information, Screening, and the Costs of Informal Lending: A Study of a Rural Credit Market in Pakistan

This article examines whether the high implicit interest rates charged by informal money lenders reflect the actual costs of operating in that market. It studies services, costs, and charges of fourteen informal market moneylenders and their clients in Chambar, Pakistan.

The article finds that:

• Each lender offers a wide range of lending services that vary in terms of the types of loan contract, accessibility to the lender, marketing services provided with the loan, and so forth;
• Pricing distortions in informal credit market, and the Government's policy regarding interest rates on institutional loans are correlated;
• Information about the creditworthiness of clients is a barrier to the entry of informal service providers.

It concludes that:

• Imperfections in the flow of information contribute to and strengthen product differentiation;
• In the short term it will be difficult to reduce the problem of imperfect information through, for example, such actions as enforcing laws to advertise the terms of loan contracts offered in the informal money markets.