Social capital and credit constraints in informal finance

Wei Liu () and Willem Spanjers ()
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Wei Liu: United Nations, Postal: Statistics Development Section, Statistics Division, United Nations Economics and Social Commission for Asia and the Pacific, Bangkok 10200, Thailand
Willem Spanjers: Kingston University London

No 2005-5, Economics Discussion Papers from School of Economics, Kingston University London

Abstract: This paper considers problems arising from contract enforcement and the atten- dant possibility of voluntary default. Loan contracts in the informal sector are rarely explicitly recorded and enforced by formal legal institutions. Repayments may be induced via informal enforcement mechanisms based on social sanctions through linked relations in repeated inter- actions. Lenders tend to use the strength these (bilateral) relations, called social capital, as a device for rationing heterogeneous borrowers. We apply the existing notion of exogenous social capital and introduce the notion of endogenous social capital. Appropriates level of social capital may promote loans that otherwise would not be granted. For small loans though, the endogenous social capital may become negative. We find that in such cases borrowers may be encouraged to take up excessive loans to increase incentives for repaying. The theoretical analysis is supported by empirical observations, mainly from China.

Keywords: Self-enforcing Contract; Social Capital; Credit Constraints; Informal Credit (search for similar items in EconPapers)
JEL-codes: C72 G32 O16 O17 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2005-04-01
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Persistent link: https://EconPapers.repec.org/RePEc:ris:kngedp:2005_005

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