Horizontal and Vertical Linkages Between Formal and Informal Credit Markets in Backward Agriculture: A Theoretical Analysis

Abstract

The paper shows that the policy of forging a vertical linkage between the formal and informal credit markets is distinctly superior to the existing credit policy of horizontally substituting the informal sector by the formal one. An inflow of subsidized formal credit to the informal lenders not only ensures better terms of borrowing to the small borrowers but also leads to higher agricultural productivity vis-a-vis the horizontal linkage case. Even if the informal sector lenders are allowed to collude, the informal interest rate is still lower in the vertical linkage case.