sufficient resources from business operations.<sup>9</sup> All other reasons for not requesting loans are classified as indicating “demand” for loans. Once we separated all those who have no demand, we consider everybody else as having a demand for loans. Therefore the demand category includes people who have demand but did not apply for loans, those who applied and were rejected, and those who applied and received a loan. In other words, the “demand” category encompasses agents in all the remaining categories (2)-(4) indicated in Figure 1.

For the _second category_ (demand but not apply) we group all people who have a demand for loan but did not apply for a loan. The _third category_ (applied and rejected) contains all people who applied for a loan but were rejected by a lender. Finally, the _fourth category_ groups all people who received a loan (we also refer to this category as people with _access_ to loans). In addition, we split the category (4) into those who received the full amount requested (4a) and those who received a smaller amount than that requested (4b). We refer to the latter category (4b) as partially constrained.<sup>10</sup> As shown in Figure 1, categories (2) and (3) are considered to be credit constrained, while categories (1) and (4) are considered as not constrained. As is clear from this classification, the credit-constrained category includes those who had demand but did not apply and those who applied and got rejected, whereas the unconstrained category contains those who do not have a demand for loans and those who have demand and are able to obtain the loans.

Credit-constrained agents include three types of agents that are undistinguishable in the survey data. The first group comprises rural agents who claim they have a demand for loans, but are not considered creditworthy because of the high risk or low return on their prospective investment. This means that the lenders may require high interest rates to compensate for increased risks, and thus those agents would not borrow. The second group encompasses creditworthy clients that could not convey the sufficient signals about their creditworthy and that lenders could not identify because of the underlying lending technology. Lastly, credit-constrained agents also include potential debtors that are willing to pay higher interest rates, but that creditors reject to avoid an adverse selection problem.

# **5. Participation in loan markets**

In the analysis of participation in loan markets, we focus on only three outcomes because of data limitations. The first outcome includes those agents that do not demand loans. The second outcome studied is the so-called credit-constrained group, which includes both those who had demand but did not apply and those who applied and got rejected.<sup>11</sup> The last outcome includes those that have demand and are

> 9 Farmers and microenterprises predominantly respond with the first of these three reasons and less than 1 percent of the total population responds with reasons (b) and (c). Among enterprises reasons, (a) is still predominant while about 5 percent of the population also claims reasons (b) and (c).

> 10 This is another possible dimension of credit constraints. However, the survey data indicates that only 3-5 percent of those who obtain the loans report that they applied for a larger amount. As a result, the incidence of “partially constrained” is minimal, and it is not studied in this report.

> 11 An interesting observation, which is consistent with other surveys in Mexico, is the low percent of rejected loan applications. As shown in Table 3, about 1 percent of the total sample and about 4-6 percent of those who applied had their loan applications rejected with similar proportions for individual entrepreneurs and enterprises. This suggests a self-selection process where those individual entrepreneurs and enterprises that decide to apply expect to get their applications approved. Rejection rates are significantly higher for formal than for informal loan applications. We find an almost perfect self-selection in informal loans markets, partly explained by the nature of relationship between borrowers and lenders. In the case of informal lenders, which include friends and relatives or local moneylenders for individual entrepreneurs and partners and shareholders for enterprises, the concept of “applying” for a loan is not quite applicable, and it is not surprising that we observe a perfect self-selection. As

8