Financial Accessibility and Interest Rates in the Informal Credit Market in India

Abstract

This paper studies the impact of new bank branch openings on the lending rates in the informal credit market in India. The implementation of a bank branch expansion policy in India after 2005 is used as exogenous variation in a Regression Discontinuity Design (RDD). The response of informal interest rates is compared between treated and control districts. We find that, after 5 years of the imple- mentation of the policy, the annual lending rates in the informal credit market fell by about 24%. To identify the channels, we attempt to decompose the effects of multiple factors and find that competition between the banks and informal lenders would explain a significant share of this fall. Thus, we conclude that opening of new bank branches poses a strong threat to the market power of the moneylenders which drives down the interest rates.