Can the availability of informal loans be detrimental to microloan repayment?: Some empirical evidence from Bangladesh

Prior to the introduction of microcredit system, informal loans were the major sources of credit for the poor. Even after the introduction of microfinance institutions, informal loans have been playing a significant role in credit market for the poor in developing countries. Household level micro data from Bangladesh shows that currently the major sources of informal credit are relatives, neighbors, and Mahajans, who are non-institutional professional money lenders. Mahajans are much more powerful in the society than the poor borrowers. While interest rates are relatively low for loans from relatives and neighbors, they are much higher for loans from Mahajans. This study explores whether or not the availability of informal loans has any effect on the repayment of microloans. In order to test the impact of multiple informal loans on the microloan repayment by a client, this study uses household level micro data from Bangladesh. The data shows that about twenty percent of the micro-borrowers borrowed at least once from the relatives and about thirty percent of the micro-borrowers borrowed at least once from the neighbors. This study uses gender, age, and education of the borrowers along with reasons for borrowing as control variables. By using an ordered logit model, this study finds that a micro-borrower’s access to low-interest informal loans, such as loans from relatives or neighbors, does not significantly deter them from repaying microloan. Taking high-interest informal loans such as the Mahajan loan, which may be indicative of financial trouble of the micro-borrower, however, lowers the probability of microloan repayment. This study finds that giving further microloan during the financial trouble of a microborrower can increase the probability of loan repayment. This study also finds that the probability of microloan repayment is higher for women, more educated individuals, relatively older people, and for borrowers with small amount of loans. These are significant findings, because loan recovery is important for the sustainability of microfinance institutions. In future, if the informal loans become almost non-existent, which is unlikely in Bangladesh context, the microfinance institutions will have to be less concerned about the impact of informal loans on them as the number of such borrowers will be very small. Until then, the findings of this study will remain significant for Bangladesh. Furthermore, the conclusions based on this data may be applicable to many other countries with similar institutional environment. This paper may help microfinance institutions in designing the optimal microloan contracts and improving loan recovery rates by taking into account the role of various types of informal lenders that exist in all developing countries.