Banking

Knowledge is power! The story of debt literacy and credit usage in rural India

Next, we provide evidence that debt literacy has a positive and significant effect on credit usage, particularly for agricultural households and women. This finding is in contrast with available international evidence that shows a negative effect of debt literacy on the level of credit. Our finding that individuals with higher debt literacy tend to hold more debt underscores the importance of debt literacy in their credit usage. We obtain similar results when we repeat this analysis on the national-level data set.

Policy implications

We provide evidence that debt literacy increases credit usage in rural India, where an unprecedented increase in the level of financial inclusion is underway.  Our contention is that debt literacy acts as an empowerment device, especially for agricultural households and women in rural areas. Higher debt literacy may have helped people in our sample seek loans from banks and other financial service providers.  For instance, those who are more debt literate may be more successful in producing the necessary documentation and completing other complex procedures to avail more formal loans, which are the predominant types of loan in our sample.

Our findings suggest that there is scope for policy-based solutions to improve the usage of formal financial services like bank-based credit by vulnerable sections of the population, that is, farmers and women. Policy could focus on improving their debt literacy to overcome the low usage of financial services, hence enabling them to make use of cheaper institutional credit. Our findings also provide lessons for financial institutions as they could use debt literacy as a factor for credit appraisal. Going beyond know-your-customer standards and income, this can help them to do risk-based pricing and provide more financial services like cash credit and individual loans.

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Limitations

One limitation of this study could be that although the instrument validity tests show that our instruments are reliable, we understand that our instruments may not be fully exogenous to the extent there could be unobserved confounders (such as psychological factors and social norms) that we are unable to capture. Moreover, the generalizability of our findings would require conducting similar studies in other regions.

Remya Tressa (@RemyaTressa) is a PhD candidate in economics at the Indian Institute of Management Kozhikode (IIMK). More about her research can be found here.

Source : blogs.worldbank.org

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