find it necessary to borrow from moneylenders or other informal sources after becoming a MFI member, for example, to keep up with a rigid repayment schedule even though it did not borrow from them before (see Sinha and Matin (1998) for discussions in the context of Bangladesh). The demand for informal loans may also increase because of indivisibility of investment projects; MFI borrowers may require additional loans to achieve economies of scale in their microcredit financed investment.<sup>4</sup> It is often argued that the ability to borrow from multiple sources may lead to unsustainable debt accumulation and condemn the poor to a vicious cycle of poverty and indebtedness.

While many practitioners would probably concur with one or the other contrasting views noted above, the interactions between the informal credit market and MFIs may be much more complex and nuanced; the price and quantity of informal credit may respond in opposite directions when MFI coverage increases in a village. For example, there can be a “cream skimming” effect where an MFI poaches away the better borrowers from the moneylender, and facing a worsened borrower pool (due to adverse selection and moral hazard) the moneylender needs to charge a higher interest rate (Bose (1998)). Another channel that gives rise to a positive effect of MFI penetration on moneylender interest rates, along with a reduction in the rural poor’s dependence on moneylenders, is noted by Hoff and Stiglitz (1998): if there are significant fixed costs in screening and enforcement, competition from MFIs may force a moneylender to increase the interest rate to cover fixed costs as the number of borrowers declines.

Since moneylenders have always been at the core of policy discussions on rural financial sector reform, one would expect the interactions between MFIs and moneylenders to be a fruitful ground for empirical research. It is thus surprising that there is little systematic evidence on the effects of MFIs on the informal credit market in general and on the moneylenders in particular. The only paper of which we are aware is Mallick (2012) that uses data for 106 villages from Bangladesh, and reports evidence of a positive effect of MFI competition on moneylender interest rates, but the effects on households’ demand for informal loans are not analyzed. A positive effect on moneylender interest rates in itself, however, does not tell us that it is an outcome of higher demand; it may also result from a change in the composition and size of the pool of borrowers in the informal markets, as noted above. To sort out the underlying mechanism(s), we need to understand the effects of MFI membership on household borrowing. An analysis of both household-level loan demand and village level interest rates allows us to differentiate between alternative hypotheses. For example, if we find that MFI penetration leads to higher incidence of household borrowing from moneylenders along with higher interest rates, this is more consistent with the demand shift explanation discussed above. In contrast, if we find that MFI membership reduces the probability of a household borrowing from the moneylender, but the

> 4 This seems plausible given the recent evidence that the entrepreneurial MFI borrowers cut their consumption to undertake indivisible investments (see Banerjee et al. (2013)).

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