Borrower transactions costs, segmented markets and credit rationing : a study of the rural credit market in Vietnam

Abstract

Before agricultural reform, cooperatives and state farms were responsible for production decisions. Rural credit was supplied by the State Bank of Vietnam branches throughout the country to cooperatives and state farms according to plan allocations. Agricultural reform began in 1981 and was then enhanced by the introduction of the household responsibility system in early 1988. This reform transferred farm management and the decision-making authority from the cooperatives to individual households. Agricultural reform and financial reform have significantly changed the shape and structure of the rural financial market. The main function of the Vietnam Bank for Agriculture, established in 1988 is now to lend to individual rural households. A new system of rural credit delivery with more di versified financial institutions is emerging from the old mono-bank structure. It is argued in this thesis that the policy of setting interest rate ceilings, the lack of a sound legal system, and the lack of experience in dealing with information relating to new clients-individual households-not only give rise to fom1al lenders' heavy emphasis on collateral requirements and a concentration on production loans, but also lead to the shifting of transactions costs to borrowers. As a result, these transactions costs for borrowers from formal sector lenders are very high, resulting in very high effective rates of interest for formal sector loans, especially small ones. Data used in the dissertation were obtained from a sample survey of 150 rural households carried out by the author in 1996 in a typical area of the Red River delta in northern Vietnam-Binhluc district, Narnha province. Borrower transactions costs are defined as all non-interest expenses that borrowers have to incur in seeking loans. The estimation of transactions costs indicates that prospective borrowers from the formal sector have to have on hand about VD 50 thousand to cover the out-of-pocket expense threshold. Borrower transactions costs are found to be an important barrier, discouraging small borrowers from obtaining formal loans. While these transactions costs are equivalent to 9. 7 percent of the loan amount for the smallest borrowers, they account for only 0.4 percent of the loan amount for the largest. The effective costs of borrowing from various lenders show that the partition of the credit market occurs at the loan size between VD 500-1,000 thousand. The estimation of the transactions costs function shows the significant relationships between transactions costs, loan amount applied for and interest rates. The larger the loan amount applied for, the higher the transactions costs, and the lower the interest rate, the higher the transactions costs. Probit estimations of the determinants of applying for credit are undertaken separately across loam from formal lenders, relatives and friends, moneylenders, and all other informal sources. The results confirm the existence of segmentation of the credit market with respect to the loan amount applied for and loan use. An analysis of the determinants of loan rationing by the formal sector is also undertaken. The probit estimation shows that loans outstanding and loan use are used by the formal sector as indicators for rationing loan demand.