Imperfect Information and Contract Enforcement in Informal Credit Market in Rural Punjab

Abstract

The paper studies the screening, monitoring and enforcement mechanism of the commission agents in rural informal credit market of Punjab. The commission agents due to imperfect information invest considerable time and efforts to screen the borrowers. However, the time invested and efforts made in screening are not the same in all the regions, and the moneylenders from a region with less number of default cases invest lesser time and make fewer efforts to screen the borrower. Though the legal system is used as an enforcement mechanism in many cases, the moneylenders do not consider it efficient. The social norms and other informal mechanisms are often used to enforce the contract, even though the effectiveness of these methods is found low in regions with large number of defaults. The farmer unions, in some cases, are reported to have obstructed the contract enforcement and also played a role in renegotiation of the contract. The study also argues that the use of informal methods of enforcement, which are instigated by inefficient legal enforcement rather than their low cost, may result in inefficiencies.