This paper examines why farm households seek informal loans in Piura, Peru, where formal lenders offer loans at lower interest rates. A panel data econometric analysis reveals that the informal sector serves various types of clients: households excluded from the formal sector but also households that prefer informal loans because of lower transaction costs or lower risk. An in-depth examination of contract terms and loan technologies permits an accurate comparison of effective loan costs and contractual risk across sectors and reveals that proximity and economies of scope enjoyed by informal lenders enable them to substitute information-intensive screening and monitoring for contractual risk and supply these various types of clients.
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