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We test two alternative models of interest rates determination in informal rural credit markets, using LSMS data from Nepal. We find strong support for a capacity-constrained collusive oligopoly model with full information about actual borrowers that supports heterogeneous interest rates. We find only marginal support for a competitive cost-pricing model with imperfect information. Price discrimination depends on the observable characteristics; caste, installment period and geographical region. Interest rates decrease as village lending capacity increases up to a certain level of capacity. Interest rates do not depend on risk related variables such as land value and loan size.

Magnus Hatlebakk

Senior Researcher; Coordinator: Poverty Dynamics