Financial Liberalization and the Development of Microcredit

Abstract

We analyze the debt origination process in which a lender offers prospective borrowers a microcredit product alongside a traditional bank loan, and the impact anti-usury mandates can cause within this credit market. This is a paper about the prospects of financial liberalization following a more flexible determination of anti-usury rates and, with it, the development of a formal microcredit market. In the presence of asymmetric information, a lender assesses a borrower's credit worthiness via a screening process, which its effectiveness is negatively affected by the opaqueness of the borrower's financial information. For this economy, an equilibrium is possible where all opaque borrowers, regardless of their true riskiness, are rationed from credit where usury rates are exogenously set too low by regulatory authorities. Were the anti-usury mandate was relaxed, these borrowers would have the option of financing through microcredit.