Will more credit increase interest rates in rural Nepal?

Abstract

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.