Centre for International Trade and Development (CITD)
School of International Studies (SIS)
Jawaharlal Nehru University (JNU)
is organizing a seminar by in-house faculty
Professor Mandira Sarma, CITD
Title: Welfare Analysis of Directed Lending Policy
Abstract : A common form of credit market intervention in developing economies is a directed lending policy wherein regulators mandate lenders to supply at least β proportion of their loanable funds to certain underserved sectors. In this paper, we analyse welfare implications of such a policy in the context of a two sector credit market consisting of underserved and mainstream sectors. Our theoretical results indicate that in the absence of directed lending policy, the optimal loan contract offered to the underserved borrower is unfavourable compared to that of the mainstream borrower, even when both borrowers have an identical project. We deduce that directed lending policy not only mitigates credit rationing of the underserved sector, but also improves total welfare of the economy when credit quota parameter β lies in (0,0.5); within this parameter space, it is possible to derive an optimal level of β that maximizes total welfare.