The essay aims to investigate the behaviour of rural credit markets by examining the lending mechanisms used by informal moneylenders. The first section discusses possible explanations for the significantly higher interest rates charged on loans to the poor and concludes that a combination of informational asymmetries and default incentives contribute to higher costs for lenders, a significant amount of which gets passed on to the borrowers. The following sections model the behaviour of the informal moneylending market and examine whether practices used by moneylenders to cope with the distortions in the credit market make a net contribution to economic welfare. The mechanism of credit rationing is explored as a tool for the moneylender to secure himself against strategic default and thus, precluding optimal consumer and producer surplus in the market. Similarly, the common practice of interlinkage is modelled theoretically to demonstrate its effectiveness in allowing borrowers to demand the optimal loan size thereby also maximizing lenders profit and ensuring optimal community surplus.