Interactions between institutional and informal credit agencies in rural India

THE WORLD BANK ECONOMIC REVIEW, VOL. 4, NO. 3: 297-327 FILE COPY 'Sept. {95o Interactions between Institutional and Informal Credit Agencies in Rural India Clive Bell In an attempt to expand rural credit and displace the village moneylender, India created a system of rural cooperatives in the 1 950s and expanded branch banking into rural areas in the 1 970s. This article examines how these measures affected the rural market. It begins with the question of how large the expansion of institutional credit has been and the extent to which it has dislodged the village and nonresident moneylenders. A detailed comparison of three major surveys of the Indian rural credit market suggests that in various guises, the moneylender is still a major source of loans. The article also examines the (weak) evidence on intermediation between the formal and informal sectors. A formal model of the interaction between the informal moneylender and institutional lender is constructed under a variety of assumptions about the exclusivity of loan contracts and the competitive structure of the informal sector. The conclusions are drawn together in the form of five proposals for public policy. In a landmark study of the system of credit and household indebtedness pub- lished by the Reserve Bank of India (RBI) in the early 1950s, the authors of the All-India Rural Credit Survey subjected the role and operations of the money- lender, who then enjoyed a dominant position as a source of finance, to critical scrutiny. They did so on the premise that, in India, agricultural credit presented a "twofold problem of inadequacy and unsuitability" (RBI 1954, vol. 2, p. 151). They envisaged only a minor place for him in their proposed solution, which took the form of a system of cooperatives covering all villages: "The moneylender can be allotted no part in the scheme [of cooperatives]. . . . It would be a complete reversal of the policies we have been advocating . . . when the whole object of . . . that structure is to provide a positive institutional alternative to the moneylender himself, something which will compete with him, remove him from the forefront and put him in his place" (RBI 1954, vol. 2, pp. 481-82; emphasis added). The author is a professor of economics at Vanderbilt University. This article was originally prepared for a World Bank Conference on Agricultural Development Policies and the Theory of Rural Organiza- tion, Annapolis, Maryland, June 14-16, 1989. This revised version has benefited from the valuable comments of Kaushik Basu, Karla Hoff, and three anonymous referees.