Human Capital and the Development of Financial Institutions: Evidence from Thailand

Village banks and other financial institutions often have very simple contracts that seem to rule out some transactions on an ad hoc basis. In one Thai village bank, for example, all loans must be in multiples of one thousand baht. If you want to borrow 1,500 baht, you are out of luck. All of the loans that this bank makes must be repaid on December 31, and the same amount must be repaid regardless of when the loan was made. A loan of 1000 baht that is made on January 1 will require a repayment of 1200 baht as will a loan of 1000 baht that was made on July 1. Clearly, the person who borrows on July 1 pays a higher interest rate. Savings transactions have similar features. For example, the amount you save must be a multiple of 100 baht. This paper examines the link between the financial contracts offered by village banks and the education of the people who run the financial institution and the institution’s customers using data on village financial institutions and households from rural and semiurban Thailand. I find that bank policies tend to be influenced more by the education of villagers than by the education of the bank manager. The results indicate that financial contracts become increasingly simple, or rigid, as village education goes from very low to intermediate levels. When village education rises above the intermediate level, bank policies become less rigid. Bank policies are also important determinants of which households participate in village banks. In general, rigid policies make it less likely that households will participate in the village bank. Since these village banks operate with no regulatory oversight, the simplicity of the contracts seems to facilitate monitoring of bank managers by depositors who often have very low levels of education. * I am grateful to Robert Townsend and Joe Kaboski for helpful discussions as well to the National Institute of Health and the National Science Foundation for funding the collection of the data analyzed here. Andrei Jirnyi provided excellent research assistance. The views expressed here are those of the author and not necessarily those of the Federal Reserve Bank of Chicago or of the Federal Reserve Board. Please address correspondence to Anna Paulson, Federal Reserve Bank of Chicago, 230 S. LaSalle Street, Chicago, IL 60604; phone: 312-322-2169; email: [email protected].