Borrowing channels, purposes, and household investment and consumption: evidence from Nepal

• Published date: 01 December 2021
• Author: Olga Kondratjeva
• Date: 01 December 2021
• DOI: http://doi.org/10.1111/joca.12355

SPECIAL ISSUE

Borrowing channels, purposes, and

household investment and consumption:

evidence from Nepal

Olga Kondratjeva

Social Policy Institute, Washington

University in St. Louis, St. Louis,

Missouri

Correspondence

Olga Kondratjeva, Social Policy Institute,

Washington University in St. Louis, St.

Louis, MI.

Email: olga.kondrat@gmail.com

Abstract

Despite the expansion of the formal financial sector in

recent decades, informal credit continues to play an

important role in the financial lives of households in

low-income countries. Using panel data from nationally

representative household surveys conducted in Nepal in

2003/04 and 2010/11, this paper investigates how bor-

rowing from different channels (formal and informal)

and for different purposes (production and consump-

tion) is associated with household investment and con-

sumption expenditure. Findings from a fixed effects

regression analysis indicate that formal and informal

loans are used to finance different spending needs, and

intended credit purposes tend to reflect actual spending

of borrowed funds. The level of household investment or

consumption spending depends on the interaction

between borrowing channels and purposes. This study

can inform the efforts to improve household access to

affordable and reliable financial services.

KEYWORDS

formal and informal credit, household borrowing, Nepal

1|INTRODUCTION

Traditional approaches to microfinance were built on a premise that a lack of working capital

was the primary barrier faced by low-income micro-entrepreneurs trying to grow their business.

Received: 31 October 2019 Revised: 7 December 2020 Accepted: 8 December 2020

DOI: 10.1111/joca.12355

Copyright 2021 by The American Council on Consumer Interests

J Consum Aff. 2021;55:1591–1613. wileyonlinelibrary.com/journal/joca 1591

To address this issue, early proponents of microfinance emphasized providing microloans for

capital accumulation and business development that could subsequently improve household

livelihoods (Yunus and Jolis, 2003). This rationale focused on the potential of microloans to

reduce household financial constraints and spur investments in entrepreneurial activities,

which could lift micro-entrepreneurs out of poverty and promote economic growth. However,

these claims have since been criticized for focusing on business activities and overlooking the

broader importance of credit for household economic development (Karlan and

Morduch, 2010). For resource-constrained households, credit helps secure access to liquidity,

which, in turn, can enable households to smooth daily consumption, manage emergencies,

recover from financial shocks, build assets, and invest resources in health or education (Collins

et al., 2009; Bauchet et al., 2011). When used to finance diverse household needs, credit can

influence the social and financial development of households in both the short- and long-term,

although research studies have produced contradictory findings on the effects of microcredit on

household well-being, including self-employment activities, and household consumption (e.g.,

Pitt and Khandker, 1998; Coleman, 1999; Karlan and Zinman, 2010; Crépon et al., 2015).

Understanding the potential of credit as the means to satisfy an array of financial needs

requires a comprehensive definition that distinguishes between credit delivered through various

channels, including formal financial institutions (e.g., commercial banks, microfinance organi-

zations, financial non-governmental organizations [NGOs]), semi-formal institutions (e.g.,

credit cooperatives), and informal networks (e.g., friends and family, moneylenders, shop-

keepers).

1

Indeed, a substantial body of research has documented the prevalence of informal

borrowing in low-income countries and the coexistence of formal and informal borrowing

(Mohieldin and Wright, 2000; Banerjee and Duflo, 2007; Guirkinger, 2008). Despite the growth

of the formal financial sector, informal credit has continued to play a vital role in household

finances. In 2017, 7.9% of adults in low-income countries had borrowed money from a financial

institution or used a credit card whereas 31.3% had obtained a loan from family or friends

(World Bank, 2018).

Despite the prevalence of informal credit markets, research has primarily focused on out-

comes of credit accessed through formal financial institutions, and less is known about the

effects of informal borrowing on household outcomes such as household poverty and well-being

(Akudugu, 2014; Viet Nguyen and van den Berg, 2014). Studies attempting to compare bor-

rowers using formal credit and non-borrowers tend to lump together non-borrowers and bor-

rowers who obtain credit from informal channels, thus failing to appropriately distinguish

between the two distinct categories of households (Dalla Pellegrina, 2011). That is, by lumping

borrowers with informal credit and non-borrowers, the studies merge those who often experi-

ence very high-interest rates (e.g., informal borrowers with loans from moneylenders) and those

who do not pay any interest. This failure to consider alternative borrowing channels leads to

inadequate comparison because credit with different terms and pricing arrangements can have

differential impacts on household well-being and spending decisions. Therefore, for both con-

ceptual and methodological reasons, accounting for the forms of informal credit is critically

important to understanding household financial outcomes.

To address this knowledge gap, this study seeks to investigate how borrowing from different

channels (formal and informal) and for different purposes (production and consumption) is

associated with household investment and consumption outcomes. In this study, loans for pro-

duction (i.e., income-generating) purposes are intended for the provision of funds for invest-

ment in agricultural activities and non-agricultural business activities (Imai et al., 2010),

whereas consumption loans are intended for non-production spending, such as immediate

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