The Technology of Lending: Informal Credit Contracts


By Amy Jensen Mowl, IFMR Finance Foundation


Despite focused financial inclusion policy initiatives and practice in India—at great cost, subsidy, and effort— high levels of informal borrowing persist, and informal lenders co-exist comfortably alongside the formal sector. This primary investigation examines the reasons for this resilience through a set of twenty informal credit products, currently used in rural and urban Tamil Nadu. I use qualitative and quantitative methods to classify diverse product technologies (such as loan screening, collateral, interest rates, and collection methods) into comparative contract structures. Results reveal that the informal lenders have adapted to changes in the formal market with a number of surprising contract innovations, while the formal lenders themselves might not be aware of these emerging contract gaps.

However, alongside contract innovations, this research also highlights a variety of tools that allow informal lenders to use borrowers’ reputation and social status in loan recovery, while similar practices in the formal sector are yet nascent. Qualitative interviews reveal that borrowers find these practices highly undesirable and have strong expectations of dignity and privacy in banking.

For practitioners looking for innovation insights, these product profiles suggest highly bankable segments, examples of tested products, and insights into customer preferences. For policymakers, this research underscores the need for strong regulation to preserve the expectations of fairness, dignity and privacy that borrowers associate with the formal sector. The product profiles also hint at inefficiencies and arbitrages in policy rules that can be re-examined, allowing contract gaps to close.

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