Symbiosis vs. crowding-out: the interaction of formal and informal credit markets in developing countries

It is a common observation in many developing countries that enterprises are active borrowers in both formal and informal credit markets. We propose a model in which the formal sector's superior ability in deposit mobilization is traded off against the informational advantage that lenders in the informal sector enjoy. The formal sector can screen borrowers by providing only partial financing for projects, thereby forcing borrowers to resort to the informal sector for the remainder of the loan. We use the model to predict how the market structure responds to changes in the environment, and we consider the policy implications of various forms of government intervention. (C) 1999 Elsevier Science B.V. All rights reserved. JEL classification: O1; D8; G2.