There are two sources of agricultural credit in a less developed economy such as India: the formal credit market, where loans come from the nationalised banks and cooperative credit societies; and the informal credit market, where loans are advanced by professional moneylenders, traders, landlords, etc. In the initial stage of economic development after independence, the share of the formal sector in total agricultural credit was very low. For example, in 1950-51, this share was only 7%. However the government of India has given special emphasis to the adequate supply of subsidised credit to the farmers in the development programme. In 1980-81, the share of formal credit had increased to 63%. When the formal credit market becomes an important source of agricultural credit, interaction between the formal and the informal markets is expected to play a significant role in the determination of the informal interest rate. Unfortunately, the recent theoretical literature on agricultural credit has not adequately treated this aspect.

If subsidised formal credit is inadequate in supply, a market for informal credit is automatically created. But in this column, we consider a case where the market for informal credit is created by delayed disbursement of formal credit. There is empirical evidence of delay in disbursing formal credit. K.Sarap has found that small and marginal farmer face substantial delay in getting formal short-term credit. The disbursement of long-term loans is more time consuming. Sarap’s empirical analysis is restricted to the villages of Sambalpur district in Orissa. The empirical analysis of S. Chaudhuri in the case of two selected villages in West Bengal points out the same problem. This problem has also been observed by Bedback, who made a survey of village of Sonpur subdivision of Orissa.

It has been observed that the time taken for formal short-term loans is inversely related to the size of the holding. This along with some other factors leads to a highly unequal distribution of formal credit against small and marginal farmers. Formal loans as a percentage of total loans are much higher for larger farmers than for small and marginal farmers.

Among the factors inhibiting the small and marginal farmers from getting formal credit in time, we emphasize on such factors as patronage; arbitrariness and corrupt practices pursued by the officials of the formal credit agencies. In addition to Sarap and Chaudhuri, these aspects have been pointed out by many.

We have undertaken a theoretical analysis of interest rate determination in the informal credit market when the market for informal credit is created by delayed disbursement of formal credit. The official of the formal credit institution who is ion charge of the disbursement deliberately undertakes dilatory tactics with a view to force the offer of bribes from the farmers, the beneficiaries. The representative farmer has two sources of credit. The farmer resorts to informal credit because there is a delay in disbursement of formal credit. An official controls the delay, and the farmer bribing the official can reduce the delay. The official has nom control over the formal rate of interest, which is administratively determined. However, the effective interest rate on formal credit must include the bribe, where the official concerned determines the bribing rate. The moneylender, on the other hand, determines the interest rate he charges for informal credit. Thus the official and the moneylender play a non-cooperative game, choosing the bribing rate and the informal interest rate, respectively, and the equilibrium in the credit market may be viewed as Nash equilibrium.

The theoretical analysis leads to some interesting results. For example, the informal sector interest rate and the effective formal interest rate may be equal in equilibrium. Development policies such as price and credit subsidies may not ultimately succeed in reducing the informal interest rate and improving the credit intensity of cultivation by small farmers. Thus even if one does not oppose these policies directly one can at least question the desirability of these policies when the problem of delayed disbursement of formal credit can’t be solved administratively.