Market for 'Right-to-Borrow': A Theory of Credit Cooperatives

Economics

Speaker:Arupratan Daripa, Birbeck College
Date: Friday 26 May 2000
Time: 16:15
Location: Room 106 Streatam Court

Further details

The paper presents a theory of a non-market collective credit organization as an optimal institutional solution to the problem of a distorted formal credit market. I construct a model in which agents have low wealth and need to borrow funds to invest in a project. The type of the project as well as the effort expended are private information of the agent.
I show that the information asymmetry coupled with lack of own wealth leads to severe distortion, and sometimes complete collapse, of the formal credit market. I show that an optimal solution to the above problem is to add a market for "right-to-borrow." Of course, since everyone has free access to borrowing, such a market could not arise. I show that a credit cooperative can implement a market for right-to-borrow, which restores first-best whenever the underlying information problem is severe.
The literature suggests that a credit cooperative can improve on formal markets because of peer monitoring or long term local interaction. In contrast, the view presented here is based on market implementation.
Finally, I investigate the role of monitoring in this model. In the literature monitoring has a direct role in improving output. Here monitoring can have an indirect effect. I show that adding a "little bit" of monitoring extends the scope of the mechanism used by the cooperative even if monitoring has no direct effect on output. While the mechanism without monitoring restores first best exactly when the information problems are severe, the augmented mechanism attains first-best at all complementary levels of information problems as well.