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

Many governments have perceived the rural moneylender as usurious.This article takes a first step toward directly testing thevalidity of this view. In a study of services, costs, and chargesof fourteen informal market moneylenders and their clients inChambar, Pakistan, the article examines whether the high implicitinterest rates charged reflect the actual costs of operatingin that market. Estimates of the resource costs incurred byinformal lenders for screening, pursuing delinquent loans, overhead,and cost of capital (including unrecoverable loans) suggestthat lenders' charges are equal to their average cost of lendingbut exceed their marginal cost. This finding is consistent withthe view that the informal credit market is characterized byexcess capacity and monopolistic competition in the presenceof imperfect information.