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Abstract
The paper uses the concept of credit limit to analyze the determinants of household
access to and participation in informal and formal credit markets in Malawi. Households
are found to be credit constrained, on average, both in the formal and informal sectors;
they borrow, on average, less than half of any increase in their credit lines. Furthermore,
they are not discouraged in their participation and borrowing decisions by further
increases in the formal interest rate and/or the transaction costs associated with getting
formal credit. This suggests that getting access to credit is much more important than its
cost for these households. Hence, credit policies should focus on making access easier
rather than providing credit with subsidized interest rates.
The composition of household assets is found to be much more important as a
determinant of household access to formal credit than the total value of household assets
or landholding size. In particular, a higher share of land and livestock in the total value of
household assets is negatively correlated with access to formal credit. However, land
remains a significant determinant of access to informal credit. Therefore, poor
households whose assets consist mostly of land and livestock but who want to diversify
into nonfarm income generation activities may be constrained by lack of capital. As
informal loans are usually too small to help poor households start a viable nonfarm business, these households may be forced to rely on farming as the sole source of income,
despite its unreliability because of the frequency of drought in Malawi.
Finally, formal and informal credit are found to be imperfect substitutes. In
particular, formal credit, whenever available, reduces but does not completely eliminate
informal borrowing. This suggests that the two forms of credit fulfill different functions
in the household’s intertemporal transfer of resources.