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Abstract

A common problem in agricultural credit markets in developing countries is the coexistence of a competitive market equilibrium interest rate and credit rationing. The literature typically explains the existence of credit rationing in competitive credit markets using adverse selection and moral hazard. Unfortunately these analyses are not consistent with the empirical reality that developing countries deal with in terms of subsidized credit, especially in the agricultural sector. This paper presents an alternative explanation for credit rationing in the agricultural sector in developing countries based on the fact that the requested loans are usually for small amounts, with many farmers making applications. As a result, the costs of operation increase with the number of loans given, so that inefficiencies in credit allocation occur when national development banks are present. It is shown that credit rationing can be reduced if shutting-down the national development bank is a feasible policy. Two other cases show that a national development bank is welfare-improving if an incentive compatible contract is used.

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