Information and Enforcement in Informal Credit Markets

This paper examines loan enforcement in informal credit markets with limited information flow. It says that the effectiveness of enforcement policies critically depends on the flow of information, hence there must be some degree of information-sharing among lenders regarding their clients, and consequently some kind of public knowledge about individual borrowers credit histories. This paper interprets limited client information in informal credit markets as a possible outcome of coordination failure among moneylenders. The authors:

• Analyze some implications of the reduced information-flow assumption;
• Stresse the heterogeneity of borrower types, and the need for a lender to screen them through the use of an initial testing phase, which may serve as a punishment for would-be deviators in the mature phase of their credit relationship;
• Consider a model with many borrowers and lenders, and studies repeated borrowing to finance working capital requirements. However, since bad borrowers always default, while good ones meet their obligations (in equilibrium), such information is revealed to the lender after one period of interaction;
• Introduces the possibility of macro-rationing, which they say is always present in equilibrium.

The paper concludes that if lenders have the option of privately collecting information on the credit histories of new clients at a cost, multiple equilibria could arise for intermediate values of such costs.