AN ECONOMIC-ANALYSIS OF RURAL INFORMAL CREDIT MARKET WITH RECIPROCITY

In the rural Philippines, the high interest rates and credit rationing are characteristic of the rural credit markets, yet it is common for much lower interest rates to be agreed upon through personal ties. We postulate that the latter type is more common because the lender induces the borrower to avoid defaulting by giving him an insurance premium such as cheaper credit through a reciprocal personal relation. To elucidate this, first we proved that the above mentioned reciprocal credit contract can be optional and sustained as a non-cooperative equilibrium in a repeated game. Second, we showed that personal relations, assets and income are important determinants of a credit contract in an informal credit market, by using Tobit type empirical model.