The New Palgrave Dictionary of Economics

2018 Edition
| Editors: Macmillan Publishers Ltd

Moneylenders

  • Amit Bhaduri
Reference work entry
DOI: https://doi.org/10.1057/978-1-349-95189-5_816

Abstract

The standard practice of moneylending in the unorganized credit market differs from financial intermediation by the commercial banks. Banks operating on the basis of a ‘fractional reserve system’ hold in cash reserve only a fraction of their total debt obligation to the public. In effect, this becomes the method of creating credit-money by the banks through the so-called ‘credit multiplier’. However, there exists no ready counterpart to such credit creation by private moneylenders in the unorganized markets. In principle, a private moneylender with a good reputation for solvency can also create private debt obligations in the form of personal promisory notes or I-owe-you’s (IOUS). And, the issue of such private debt obligations can even be several times the cash in reserve with him, in analogy with the credit multiplier of commercial banking. Although such private debt obligations are not uncommon in some less monetized rural areas or in the informal banking sector (coexisting side by side with the formal banks in urban centres) in many underdeveloped countries, the issuing of such private debt obligations must be intrinsically far more restricted in scope for at least three reasons. First, without either a legally stipulated ‘cash reserve ratio’ or an institutional ‘lender of the last resort’, private moneylenders have to rely entirely on their personal creditworthiness, in case there develops a sudden ‘run’ on their debt obligations. Second, personal reputation must normally be spatially restricted to relatively small areas. In turn, this tends to fragment the unorganized market for credit. Finally, many private moneylenders, especially in the poorer rural areas of underdeveloped countries do not act as proper financial intermediaries. Instead, as the name suggests, they are primarily lenders of money (usually out of their own savings), but not takers of deposits. And, not being financial intermediaries, the income or profit for this class of moneylenders cannot be explained in terms of the margin of their lending rate over the deposit rate, unlike in the case of commercial banks. This suggests a different mode of operation in terms of the profitability of private moneylending in the unorganized market. For example, the private moneylender must get a higher rate of return on the loan he advances from his personal savings than he could secure from deposits with banks in the organized credit market to make such activities economically worthwhile for him. It is the task of economic theory to explain how this may come about without financial intermediation.

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Bibliography

  1. Tun Wai, U. 1957–8. Interest rates outside the organized money markets of underdeveloped countries. IMF Staff Papers 6: 80–142.Google Scholar

Copyright information

© Macmillan Publishers Ltd. 2018

Authors and Affiliations

  • Amit Bhaduri
    • 1
  1. 1.