Credit Restrictions (Rural India)

India imposes caps on lending rates in rural areas and forbids lenders from discriminating across small borrowers. We study the impact of this regulation on household outcomes, particularly the use of capital and child labor. To do so, we first build a model economy that replicates outcomes from a survey of Indian households, in particular with respect to lending rates, the use of informal moneylenders, and child labor. Then we remove the lending regulation and find that the formal sector can then fully serve the loan demand at rates that are lower than those charged by informal moneylenders. This increases the loan mass, particularly for low-risk borrowers, and thanks to the increased use of capital, improves adult wages and human capital sufficiently to cover subsistence consumption and thus avoid child labor. Consumption is 25% larger and welfare, as measured by consumption equivalents, is improved by 59%.

From the new working paper "Loan Regulation and Child Labor in Rural India," by Dasgupta & Zimmermann (October 2012).