Part4|DF201|Question 5

Bhaduri,A (1977) "On the Formation of Usurious Interest Rates in Backward Agriculture", reprinted from Coats and Khatkhate (1980)

Indian Political Economist Amit Bhaduri has wrote about two things that help determine rural interest rates.
1. Power relationships explicitly play into the analytical framework.
2. Subjective factors are allowed into the valuation of securities and collateral for which there are no established markets. Thus the monopolist may be able to extract the monopoly profits from ceasing assets that he valued for security too low. And he describes as "gross undervaluation". u=p/p^ and u>=1

Thus neither the opportunity cost of capital nor the default rate can be considered to be exogenous.

Two specific mechanisms make life difficult for peasant borrowers:
The Interest rate (money lenders can accumulate assets priced too low through the transfer of collaterals)
Undervaluation of collateral (mentioned earlier) also represents 'personal power' in unorganized/rural markets.

p=nominal market value (assuming one exists-and probably highly unstable in prices)
p^=price at which lender will accept
p(b)=borrowers personal valuation
p(l)=lender personal valuation
z=(p(l)/p)*(p/p^)

Thus, the nature of the "equilibrium" solutions is now clear: the lender will push the optimal interest rate so high that repayments of principal plus interest will exceed the value of the collateral transferred to him; but the borrower may still be willing to repay the principal and interest at that rate rather than default, only because he attaches a personal value to the asset which exceeds its market value and its vale to the lender.

But this seems to assume there is no societal pressures that hinder the lenders ability to confiscate the collateral. If the lender is the most powerful individual in society he may also face a diminishing marginal value from confiscating property.

...forced default is the very essence of the economic phenomenon of usury and emerges as a logical consequence of our model. The rate of interest is then seen to operate as a convenient device in the hand of the rural money-lender for accumulating assets, through the transfer of undervalued collateral deliberately brought about by large-scale default. This reason for ruinously high rates of interest has always been well known to poor peasants taking loans on desperate terms...

Links:
For a nice discussion of Developing Economics, [url=http://www.ciat.cgiar.org/webciat/planificacion_rural/Taller_Territorio/FAO/SDAR/Typology_Decentralization/CD_typology/docs/ac158e08.htm]Country case studies: Thailand[/url] and it also talks about cooperatives including Credit Cooperatives.

Decentralized Rural Development and the Role of Self Help Organizations

A nice but long piece on rural financing atFINANCIAL SERVICES FOR THE POOR AND POOREST: DEEPENING UNDERSTANDING TO IMPROVE PROVISION by: Imran Matin, David Hulme and Stuart Rutherford