The Determination of Interest Rate by Informal Lenders in Cabuyao and Los Banos, Laguna, 2018

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The information that will be obtained from this study can help policymakers better understand the informal sector and implement policies that will not eliminate the informal lenders but rather complement its services together with the formal sector.

Objectives of the Study

The main objective of the study is to determine the factors affecting the interest rates charged by informal lenders with regards to the level of development in Los Baños and Cabuyao, Laguna. Specifically, the objectives of the study are:

- to describe the informal moneylenders in Cabuyao and Los Baños, Laguna;

- Analyze how the informal moneylenders operate in the Cabuyao and Los Baños, Laguna;

- To determine the farmer’s perception regarding interest rates charged by informal lenders; and

- To determine the factors affecting the determination of interest rate by the informal moneylenders in Cabuyao and Los Baños public markets.

REVIEW OF RELATED LITERATURE

Despite the stigma against informal lenders, their role as providers of credit cannot be overlooked since they are the ones that provide the majority of credit to small farmers. This section is divided into five parts; the first one dealing with the history of agricultural credit, the second one deals with the categories of rural financial institutions, the third focusing on informal credit providers in the Philippines, the fourth is on the definition of interest rates while the last one looks into the policy and regulatory environment where the informal sector participates in.

History and Nature of Agricultural Credit

Credit predates money wherein people trade by promising to the other party that the debt will be paid on a future date. Credit is important since it spurs capital formation which will lead to higher productivity. The type of credit involved in here is called “production credit” (Garcia, 2011). This type of credit is the capital used by people to start businesses or expand their businesses. The other type of credit is “consumption credit”; which is what people use to buy cars, houses etc. Credit just like money can be used to stimulate demand. In an economy where there is no credit, “the growth in demand is constrained by the growth in production”. This is the reason why credit is important for the economy and to the agriculture specifically. It leads to higher productivity by letting farmers get what they need now to get a higher return in the future.

Categories of Rural Financial Institutions

Financial institutions in the Philippines can be divided into two. Despite this classification, there are still structures in between the formal and informal sector so the financial institutions can be best described as a continuum as opposed to a dichotomy (Agabin, 1988). These are the formal and informal financial institutions. Formal financial institutions can further be divided into two: banks and non-banks. Examples of banks are universal banks commercial banks rural banks, thrift banks etc. while non-banks include insurance companies, lending investor pawnshops and investment houses (Corales and Cuevas, 1987). These institutions tend to be conservative so small farmers and fisher folks are not their priority due to the higher risks associated with these people (Llanto, 2005). According to Agabin (1988), one third of the voting age population in the Philippines borrow and two thirds of these borrow from the informal sector so a detailed study of informal lenders is needed because of this statistic. The informal sector is composed of private moneylenders, input suppliers, traders, relatives and friends. They are not regulated by any regulatory agency but they play a more proactive role in agricultural development (Corales and Cuevas, 1987). According to Llanto (2005), the share of the informal sector in the total loans provided to the agricultural sector is much higher than the formal sector. The informal sector also accepts collateral substitutes as a replacement for the usual real estate that bank require from their borrowers. Examples of collateral substitutes are usufruct rights and credit marketing tie-up.

Informal Credit Providers in the Philippines

The informal credit providers still exist in a developing country such as the Philippines because of the excess demand for credit by the agricultural sector which banks and other financial institutions failed to supply to those who needed it because of the relative riskiness of the industry as compared to other alternatives. The informal credit providers simply serve the purpose of lending to the underserved sector. According to a study by Agabin (1988), friendship and personal ties are the foundation in which these informal lenders operate because the people close to the farmers are the ones that they can easily approach if they have credit needs. The cost of borrowing may be high from a relative or a friend but the borrower will prefer it because of the convenience and the trust that they have developed through time. Informal credit providers are not generally covered by any regulatory body but some marketing intermediaries in agriculture such as input suppliers, traders, and millers act as lenders to their clientele and some of them, especially the well-established ones, are still covered by some regulatory agency (Agabin, 1988). Most informal lenders use internally generated funds to lend out to borrowers although there are a few who mobilize the savings of members (in the case of a credit cooperative) and others who borrow. Still, the main constraint among these small-scale lending operations is the size of their loanable funds. This results in increased risk since most of them lend to a homogenous group of borrowers who probably have the same credit worthiness. The formal financial sector still lends to the agricultural sector but they are biased towards large farm owners since they can present acceptable loan collaterals unlike the small farmers (Llanto, 2004). Despite the low interest rates offered by these formal financial institutions, small farmers still borrow from informal lenders because of the hassle of meeting the required loan requirements by the banks. The banks and other government financial institutions may want to lend to the agricultural sector but they still face constraints that informal lenders were not subjected to such as information asymmetry, risk costs, and transactions costs (Llanto, 2004). The informal lenders were able to avoid the same problems because of their