From Pawn Shops to Banks: The Impact of Formal Credit on Informal Households

This paper examines the effects of expanding access to credit on the decisions and welfare of households. I focus on the entry of Banco Azteca, the first bank in Mexico targeting households from the informal sector. Panel data suggests that informal households in municipalities with Banco Azteca experienced several changes in their saving, credit and consumption patterns. In order to estimate the impact of Azteca’s entry, I develop a dynamic model of household choices in which the bank is endogenously selecting the municipalities for branch openings. I find that in municipalities in which the bank entered, households were better able to smooth their consumption even though the overall proportion of households who save went down by 5.8%. These results suggest that the use of savings as a buffer on income fluctuations declines once formal credit is available. What is more, these effects vary across households with the poorest ones having the highest decline in saving rates. The model is also used to evaluate the proposed legislation to cap interest rates levied by formal credit institutions. Simulations suggest that if the Mexican government were to cap the interest rate of Azteca at the rate for traditional banks, Azteca would stop operating in the poorest and least populated municipalities. [email protected] I would like to thank Sandra Black, Moshe Buchinsky, Maria Casanova, Dora Costa, Pascaline Dupas, Fred Finan, Ahu Gemici, Adriana Lleras-Muney, Kathleen McGarry, Alvaro Mezza, Bernardo Morais, Leah Platt Boustan and Hernan Winkler for very helpful discussions and comments. I am extremely grateful to my advisor Maurizio Mazzocco for his invaluable suggestions and guidance. All errors are my own. Please refer to this site for the most recent version of the paper: https://sites.google.com/site/claudiaruizortega.