ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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The Invisible Collateral

A borrower may hesitate to borrow from her close relatives and family members as it costs them in terms of reduction in social insurance in the case of default. This invisible cost reduces credit risk. India’s household indebtedness survey shows some evidence on these borrowing preferences. This perspective on borrowing decisions derived from the community can be used as one of the dimensions in credit risk evaluation and in policy formulation.

In a society, reciprocal behaviour among members help individuals achieve social and economic objectives. Rational individuals in communities strategically become members of a social network to reap the benefits by being a part of it (Jackson and Watts 2002). Inside the network, when individuals cooperate with each other, they could act collectively to gain economic values. The level of cooperation will depend on the level of trust among individuals inside the network. This kind of trust in a network acts as a lubricant in economic transactions among the members of the network (Arrow 1974). Thus, we can argue that an individual’s pay-off to participate in the network will be a function of an ex ante assigned belief or trust by the individual on certain actions of others inside the network. Therefore, individuals in the network are likely to build trust over time to enjoy the benefits of being trustworthy (Coleman 1988; Granovetter 1985). Any loss of trustworthiness in the network will bring disutility for the individual, as others may not cooperate with them as before.

Inside a social network, loss of trustworthiness is most likely to be reflected in the frequency and amount of financial transactions among members of the network. In an informal credit market, pledged collaterals in the case of secured credit act as a deterrent for borrowers to default. However, in the case of unsecured credit, a borrower is likely to lose non-monetary collateral in the form of social trust in the network (Karlan et al 2009). We call this invisible collateral, because the trustworthiness is invisible to public in general. However, this invisible collateral can be a deterrent for the borrower to default.

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Updated On : 6th Dec, 2019

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