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Interest Rates in Informal Credit Markets and Their Impact on National Accounts
Informal credit markets cater to households and unincorporated enterprises. Despite charging high rates of interest compared to formal financial institutions, they add significant value. In this article, the structure of interest rates charged by moneylenders is examined, based on the results of the All India Debt and Investment Survey 2019, which provides information on households’ outstanding cash loans, classified by interest rate ranges and each credit agency. Similar data collection is necessary for unincorporated enterprises.
There are no empirical studies on informal credit markets in recent years, mainly because of an inadequate database. The only exhaustive study was published in 1984 by Timberg and Aiyer, who analysed the interest rates charged by moneylenders, indigenous bankers and the destination of credit to different sectors, based on information they garnered from detailed enquiries. But the data in this study is from several decades ago, when institutional sources of credit1 did not gather momentum, while non-institutional sources2 played a prominent role.
Over the last few decades, the share of non-institutional sources has declined due to the implementation of schemes by banks for financial assistance to weaker sectors of the economy. However, the role of non-institutional sources, particularly moneylenders, is not insignificant. The informal credit markets cater to the financial requirements of households and unincorporated enterprises, and charge high rates of interest in comparison with formal financial institutions. Yet, even the net value added by this sub-sector is not insignificant. While formal financial institutions provide credit on a relatively large scale, the interest rate spread, that is, interest paid net of interest received, is marginal.
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