Credit-Rationing Behavior of Agricultural Lenders: The Iron Law of Interest-Rate Restrictions

Abstract

This chapter explores the determinants of the behavior of borrowers and lenders under interest-rate restrictions. The changes in loan size implied by the Iron Law of Interest-Rate Restrictions cause a redistribution of the loan portfolios of the formal financial institutions (FFIs), as the non-rationed borrowers get larger shares of these portfolios and the rationed borrowers get smaller shares. The chapter also explores models of non-price credit rationing and of rationing through the noninterest terms of the loan contracts to show how interest-rate ceilings restrict the access of small farmers to institutional credit and how this results in a high degree of concentration of the loan portfolios of the FFIs. Several models of lender behavior can be used to explain rationing decisions. When banking and economic criteria are replaced by administrative and political decisions, the credit-rationing process becomes more vulnerable to pressures from specific borrower groups, and loan portfolios become more concentrated.

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