When do enterprises prefer informal credit

This ensures that procrastinated procedures and paperwork in setting up credit operations is avoided, encouraging wider participation and ease of entry. However, simple steps like registration of a people's organization as a "society" or association under the law will provide legal validity for such groups Note: money lenders and pawn brokers have to comply with the Money Lenders Act and Pawn Brokers Act respectively - but compliance and enforcement is rare.

It facilitates very small savings behaviour. Low incomes also mean that the amount saved is very small, since most of the income is used for consumption purposes. The small amounts saved is not attractive to banks, but find ready acceptance in the informal credit groups.

A typical example was a women's group, Mahila Mandal, in a squatter settlement. One of the women, appointed as a "treasurer" normally sat in her front yard doing her household chores. Women who returned from their daily shopping simply passed on all the small change they had with them to the treasurer, who made a notation of the amount in a ledger she kept with her.

The money saved was small - about Rs. Most of the credit activity are based on the principles of solidarity and mutuality of actions. They are not motivated by profit. Democratic decision-making processes within the group ensures that benefits, if any, of the credit transactions are evenly distributed to all its members.

Credit activities by groups are, in many cases, part of the overall activities of an organization, for example, a women's group or a youth club and hence involves a democratic setup. These groups have a president, a secretary, a treasurer and members. With the assistance of a social worker or an NGO, they also draw up "constitutions" and have the group registered as a voluntary society.

Informal and semi-formal credits show a little influence on consumption. Informal loans have a significantly positive effect on healthcare expenditure. In contrast, having semi-formal loans tends to decrease spending on foods.

According to Negeri ; Nguyen, Nguyen, and Ho , savings and subsidies have not contributed to a clear economic well-being improvement of the households, especially in rural areas.

Therefore, credit plays a critical role in improving the wellbeing of households in developing countries. Households with access to credit are more likely than those without such access to pursue promising, but risky technologies, and will be better able to avoid risk-reducing, but inefficient livelihood strategies.

In Vietnam, there are more than two-thirds of the population living in rural areas. The demand for credit among the rural population is considered huge and diverse. However, like elsewhere, the poor and farmers in Vietnam have difficulties in accessing formal credit channels i. They also are usually better informed about the personal circumstances of borrowers and have lower monitoring and enforcement costs. Borrowers feel comfortable with less procedure, flexible credit terms, and quick processing time.

While the barriers of formal credit have not been removed, informal credit continues its complementary role to the mainstreaming financial system and absorbs the unmet demand from the formal market. Given the coexistence of both types, however informal credit, due to its informality, is not well investigated and its effects on household wellbeing are questioned.

The research focuses on two sub-questions. First, how formal and informal credit improve well-being measures such as consumption, education, and healthcare? Second, does formal credit outperform informal credit in supporting households? This study is expected to contribute to the limited existing quantitative empirical evidence on the roles of both formal and informal credit and policy implications.

The remainder of the research is structured into four parts. The second part is a literature review, followed by the evaluation method. The findings and conclusions are presented in the last two parts. Currently, the rural credit market is segmented into three sectors: informal, semiformal and formal see Figure 1. Agribank is the first formal bank in Vietnam that specialized in serving rural areas and small and medium enterprises engaged in agricultural activities.

The new entry of these banks increases the competition and the diversification of products in this market segment. The network of PCFs was founded in to provide financial services to communes, following the basic principles of cooperatives as self-help and mutual support. By , there were 1, PCFs in over 10 percent of communes, serving approximately 1.

In , the central PCF was transformed into Cooperative Bank but the network of local credit funds still operates as usual. The VBSP is currently the biggest microfinance provider serving 7 million clients including depositors and borrowers of which 6. VBSP owns the largest network of branches covering 99 percent of communes communes of districts of 64 provinces nationwide VBSP, The preferential loans from VBSP do not require collateral and are highly subsidized.

The semi-formal sector is occupied by non-licensed national programs, microfinance programs, and saving and credit schemes supported by NGOs and donors. These providers offer under VND 10 million loans on the group-lending scheme and require participants to make frequent compulsory savings as a condition for accessing micro-credit.

Furthermore, the capacity of semi-formal institutions mainly relies on technical assistance from political and social organizations such as woman union, youth union, and farmer union. Thanks to this, the poor and women are reached by these institutions and less likely to be excluded. However, semiformal institutions still encounter high operating costs and limited outreach due to their small scale. The informal credit providers include moneylenders, rotating savings and credit associations ROSCAs , pawnshops, relatives, and friends.

The simple and quick procedure is the most attractive feature for the participants especially in urgent needs of cash. Conventionally, relatives and friends are the first sources of credit that households seek when they have income shocks or unexpected events.

Free interest rate, prompt delivery, flexible duration and payment schedule are the characteristics of loans from family and friends Tran, If borrowers are rationed out by family and friend sources, they have to rely on moneylenders or traders for their emergency expenditures such as illness, funeral, and wedding. Moneylenders in rural areas often live in the same communes with borrowers and may provide loans in the form of cash or goods.

They can be permanent or seasonal lenders. They do not require collateral and offer flexible terms of payment but usually charge high-interest rates. Moneylenders have their own methods to force borrowers to repay. Households are reluctant to report their loans from moneylenders because this implies they are in not good financial standing. A ROSCA consists of members who know and trust each other and who contribute property to form a periodic saving and lending process Lainez, Interest rate, loan amount, and distribution are determined by mutual agreements among members and group leaders or by bidding.

There are some quantitative studies on the impacts of credit on poverty in Vietnam. Using the cross-sectional data from two Vietnam Household Living Standard Surveys VHLSSs and , Quach, Mullineux, and Murinde analyzed the effect of total borrowing from both formal and informal sources on household welfare. It was found that household borrowing was driven by the age of household head, household size, land ownership, savings and credit availability at village levels. Quach, Mullineux, and Murinde showed significant and positive impacts in terms of per capita expenditure, per capita food expenditure and non-food expenditure.

Especially for poorer households, credit had a greater positive effect on economic welfare. Continuing the topic, Nguyen used the data from the two VHLSSs in and to study the impacts of the governmental micro-credit program, which was implemented through VBSP for the poor. However, he found that the program in the period did not target well at the poor as Only 12 percent of poor households in rural areas participated in the program in and received a smaller amount of credit than non-poor households.

For participating households, the program generally had positive and statistically significant impacts on consumption and income per capita, the poverty rate, poverty gap, and poverty severity. Moving on to the role of informal credit, Nguyen and van den Berg evaluated its impacts on poverty and equality. First, informal credit was confirmed to be an important source of finance for the poor in Vietnam.

The statistics from VHLSS and in this study showed that informal sources were more popular to the poor than to the non-poor. Loans from friends, relatives, and families were more prominent than loans from private moneylenders and accounted for 76 percent of total informal loans.

They found that the effect of credit from friends and relatives on per capita expenditure was positive but not statistically significant. Loans from private moneylenders had a positive and statistically significant effect. Interestingly, they found empirical evidence that informal credit, especially from private moneylenders, could be an effective tool to increase household welfare, and reduce poverty and inequality.

Focusing on another aspect of poverty, Lensink and Pham , using VHLSSs and , evaluated the effects of micro-credit on household self-employment profit in Vietnam. They found that the VBSP micro-credit programs enhanced household self-employment profits and exhibited some poverty-reducing effects with the evidence on stronger positive impacts for the poorest households. If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form.

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Yazigi email available below. Please note that corrections may take a couple of weeks to filter through the various RePEc services. Economic literature: papers , articles , software , chapters , books. FRED data. My bibliography Save this paper. When do enterprises prefer informal credit? This paper tests the hypothesis that enterprises may forgo formal finance in lieu of informal credit by choice.

They do so to avoid the additional regulatory scrutiny and harassment that engaging with the formal financial sector invites. We test this hypothesis using enterprise-level data on 3, enterprises in 29 countries. In this sample, enterprises finance approximately 57 percent of their working capital requirements with external finance. This external finance comes from formal sources, such as commercial banks 53 percent and informal sources 42 percent , such as trade creditors, or family and friends.

They do so to avoid the additional regulatory scrutiny and harassment that engaging with the formal financial sector invites. We test this hypothesis using enterprise-level data on 3, enterprises in 29 countries. In this sample, enterprises finance approximately 57 percent of their working capital requirements with external finance. This external finance comes from formal sources, such as commercial banks 53 percent and informal sources 42 percent , such as trade creditors, or family and friends.

In our sample, 14 percent of enterprises rely exclusively on informal finance.