RISK,WEALTH, AND SECTORAL CHOICE IN RURAL CREDIT MARKETS
STEVE BOUCHER AND CATHERINE GUIRKINGER
We model the role of the informal credit sector in developing countries. The informational advantage
of informal lenders is portrayed as the ability to monitor borrowers. Monitoring reduces the incentive
problem and allows for contracts with lower collateral. This enables informal lenders to serve both
individuals who cannot post the collateral required by the formal sector and those who are able but do
not want to post collateral. The model is consistent with the conventional view of the informal sector
as recipient of spillover demand from the formal sector. It also shows that the informal sector may
provide partial insurance as the lower collateral requirement implies greater consumption smoothing
for borrowers.