Small Business Finance - Implication of Delay in Loan Sanctions By Formal Sector

Abstract

The small business finance is characterized by the existence of formal and informal credit market. This paper looks at the operation of formal and informal credit market in terms of a model. It first considers the hierarchical structure of the formal lending sector and shows emergence of delay in loan disposal as a pooling equilibrium among all types of officials. The paper then presents the loan negotiation process in the formal sector as one of bargaining and uses the results of Rubinstein's bargaining game. It is shown that in the context of this game, the possibility of delay in the settlement of the loan negotiation can induce some of the borrowers to leave the formal credit market and go to the informal market. This explains the coexistence of both types of credit market. The paper therefore has the policy conclusion that the formal sector should look at the behavioural aspects of the loan officials and design policies that cam prompt the officials to reduce the time span of loan settlement process for small business finance. Moreover, given the different nature of the formal and informal market, the policy on formal sector should focus on supplementing rather than supplanting the informal market.