Barriers to Credit Access in Rural Sri Lanka

Abstract

A key problem in any comparative analysis of formal and informal finance is how to determine borrowers’ preference for specific savings and credit systems. Many policymakers -both supporters and opponents of cheap credit policies -assume that borrowers base their decisions on one particular loan component, that is, the interest rate. However, other costs of loan transactions might have a much more decisive impact on decisions of (potential) borrowers. The transaction cost analysis, attempting to identify all costs incurred by borrowers and lenders, has shown that interest rates are but one of a set of borrowers’ transaction costs. These costs usually include travelling costs to the credit institution, opportunity costs of labor for the time lost in lengthy application procedures, and expenses of updating or organizing legal documents used as collateral. For more than two decades, analysis of borrowers’ transaction costs has served as the analytical tool to investigate decisions of borrowers pro or contra informal and formal lenders. However, I feel that transaction costs cannot explain borrowers’ decisions comprehensively. These costs imply a ranking order by borrowers: the cheaper the credit source, the more likely they will try to get a loan from that source. Empirical evidence from my surveys in Sri Lanka suggests there is more at stake. This chapter introduces an alternative analytical framework based on these field surveys. The objective is to identify the existence and scale of entry barriers into formal and informal segments of financial markets.