Managing Rural Institutional Credit: Lessons From Interlinked Transactions

Abstract

In recent years, the focus of numerous rural credit institutions, which includes lenders from both formal and semi-formal (the micro-finance providers) domains, has started shifting from traditional credit-alone approach to interlinked credit transactions. Under interlinked arrangement, lenders intervene simultaneously with credit as well as in markets of credit complementary services. The argument behind evolution of such interlinked transactions is, in the absence of efficient markets in factor services to cope with the problems such as seasonality, asymmetric information, non-standard factor services, and uncertainty in input supply, adverse price fluctuations and opportunistic behavior of factor suppliers— all typical of poor agrarian societies— interlinked credit seems to provide a good solution. However, in spite of existing theoretical as well as empirical literature on the subject, there is still a lack of persuasive arguments and evidence to establish interlinked transactions as an effective management tool in achieving success in delivery of rural credit, which is a problem in the formal credit sector.

The dissertation proposes that the efficacy of interlinked credit ought to be understood in the context of competition among formal, semi-formal and traditional informal credit. Against this backdrop of competiveness, this study attempts to bring out three important aspects of interlinked credit, first, it attempts to determine factors influencing the choice of interlinked credit, second, it demonstrates that, as compared to credit-alone approach, interlinked arrangement improves access to institutional credit, and third, interlinked transaction ensures delivery of credit of adequate amount at better terms and conditions in terms of interest rate and transaction cost. On the theoretical front the dissertation employs an agricultural household model in a general equilibrium format, while for empirical investigation this dissertation makes use of a cross-sectional data set of 600 rural households selected through stratified random sampling spread over six Indian states.

The first part of the estimation procedure undertaken in the study follows two-step sample selected ordered probit models to correct the selection bias. The first step captures the determinants of access to credit, and the next step brings out, among the households having access to credit market which factors determine whether a household would opt for minimalist credit, or avail single interlinked credit or go for multiple interlinkages. Another two step model determines factors influencing whether a household could meet its credit demand solely from the formal sector or, partly from formal sector and partly from semi-formal and/or informal sector. Thus, in the first step a binary probit model estimates the probability of access to credit and in the second step ordered probit estimates the response variables in a hierarchical order. The study found corroborative evidence that access to institutional credit along with households‘ profitability of production activities as well as resource endowment are also determined by interlinked credit offerings.

Till date scholarly contributions to the field of interlinked credit are confined largely to the domain of informal credit under imperfect market conditions and primarily with only one kind of interlinkage at a time. This dissertation shows the scope of multiple interlinkages across broader institutional settings, which include formal, semi-formal as well as informal segment in a competitive framework. Under multiple interlinkage, credit facility may be linked with as many complementary services such as insurance, input, output and consumption. Estimation is done through seemingly unrelated regression, which accounts for simultaneity because of correlation among cross-equation random errors, which are otherwise not addressed under ordinary least square method. The results show the benefits of interlinked credit such as higher credit off-take,and better terms and conditions such as lower interest rate and less transaction cost as compared to the credit-alone transactions.

The research demonstrates to the policy makers the benefit of offering institutional credit in a more general equilibrium framework through offering credit complementary services. It strongly suggests product bundling as a potential marketing strategy for the existing as well as new entrants in the rural credit market.