Changes in Social Network Structure in Response to Exposure to Formal Credit Markets

Abstract

Formal financial institutions can have far-reaching and long-lasting impacts on informal lending and information networks. We first study 75 villages in Karnataka, 43 of which were exposed to microfinance after we first collected detailed network data. Networks shrink more in exposed villages. Links between households that were unlikely to ever borrow from microfinance are at least as likely to disappear as links involving likely borrowers. We replicate these surprising findings in the context of a randomized controlled trial in Hyderabad, where a microfinance institution randomly selected neighborhoods to enter first. Four years after all neighborhoods were treated, households in early-entry neighborhoods had credit access longer and had larger loans. We again find fewer social relationships between households in early-entry neighborhoods, even among those ex-ante unlikely to borrow. Because the results suggest global spillovers, which are inconsistent with standard models of network formation, we develop a new dynamic model of network formation that emphasizes chance meetings, where efforts to socialize generate a global network-level externality. Finally, we analyze informal borrowing and the sensitivity of consumption to income fluctuations. Households unlikely to take up microcredit suffer the greatest loss of informal borrowing and risk sharing, underscoring the global nature of the externality.