Imperfect Information, Screening, and the Costs of Informal Lending: A Study of a Rural Credit Market in Pakistan

Abstract

Many governments have perceived the rural moneylender as usurious. This article takes a first step toward directly testing the validity of this view. In a study of services, costs, and charges of fourteen informal market moneylenders and their clients in Chambar, Pakistan, the article examines whether the high implicit interest rates charged reflect the actual costs of operating in that market. Estimates of the resource costs incurred by informal lenders for screening, pursuing delinquent loans, overhead, and cost of capital (including unrecoverable loans) suggest that lenders' charges are equal to their average cost of lending but exceed their marginal cost. This finding is consistent with the view that the informal credit market is characterized by excess capacity and monopolistic competition in the presence of imperfect information.