Interest-Free Loans between Villagers

Loren Brandt and Arthur J. Hosios focus on a cross-sectional sample of informal loan contracts among households in different low-income rural villages, emphasizing the similarities and differences among positive-interest rate (PIR) and zero-interest rate (ZIR) loans. When court enforcement is absent, contracts are designed to ensure that each party has an incentive to fulfill its obligations. The enforcement constraints that their ZIR and PIR loan agreements must satisfy are basically the same concerning any pair of contracting households. The benefit of a loan of given size for a borrower is the same whether the loan entails explicit interest or not. Loren and Arthur feel cost is the key difference. ZIR loans are slightly more likely to be between villagers and households tied by kinship. They feel that having a lender and borrower who are related or live in the same village is not synonymous with negotiating a ZIR loan.