Credit Rationing in Informal Markets: The Case of Small Firms in India
Social Science Research Network
Using a unique dataset combining survey responses with panel data of reported financial activities of a sample of small and medium enterprises in India, the present study examines availability of different types of relationship-based credit, including credit driven by business relationships and social relationships. We find evidence of rationing for each type of credit. A high interest rate necessary to clear the market for loans creates a "debt overhang" for the smaller borrowing firms who
... owing firms who capture a relatively small part of the returns given their large debt repayment obligations. To limit moral hazard on the part of the borrowers in this situation, credit providers decline to extend credit beyond a certain point regardless of the credit terms. Even if relationships mitigate information asymmetry problems, moral hazard concerns still constrain credit supply. This is the first study to document rationing of informal credit. Our findings have important research and policy implications.