Repaying Microcredit Loans: A Natural Experiment on Liability Structure

Abstract

This paper utilises a natural experiment – the shift from individual to joint lending by a microfinance organisation in Pakistan – to show significant improvement in borrower discipline under joint liability loans. I find that a possible mechanism for this impact is the degree of pre-existing social connection between the group members. For the mechanism analysis, I use the exogenous variation in the number of months borrowers had till the expiry of their individual liability loans at the time of the announcement of the shift to joint leading as an instrument for the degree of social connection of the group.

Acknowledgements

I am grateful to the organisation Akhuwat for sharing month wise borrower data, to the School of Economics, University of Kent for providing the financial assistance for the survey work and to Research Assistants Arslan, Mahniya, Omair, Saba, Shahzeb, and Ubair without whom it would not have been possible to conduct it. This paper has greatly benefited from discussions with Guy Tchuente and Zaki Wahhaj. All remaining errors are my own.

Disclosure statement

No potential conflict of interest was reported by the author.

Supplementary material

Supplementary Materials are available for this article which can be accessed via the online version of this journal available at https://doi.org/10.1080/00220388.2019.1632432

Notes

1. Default rates are extremely low (less than 0.2%) making missed payments a more relevant measure for borrower performance in this setting. Missed payments are costly for the organisation since the loan officer must investigate the reason for non-payment and follow up to ensure payment.

2. Borrowers were asked whether they knew their group members, met them weekly or sometimes, would borrow in times of need, are neighbours, are of the same cast and if they had done business together before the group was formed to borrow together.

3. As measured by the borrower knowing the group members from before, meeting weekly and being neighbours.

4. MFIs such as the BancoSol in Bolivia and the ASA in Bangladesh have converted a large part of their portfolios to individual lending and even the Grameen Bank has relaxed the strict joint liability clause for defaulters.

5. This information was obtained in a meeting with Akhuwat Regional Manager Mr.Aftab Hussain in August 2014. He was part of the core team at the time changes were introduced in 2011.

6. These borrowers with ongoing individual liability loans could not borrow under joint liability until their entire individual liability loan was paid back.

7. This rate of 30% is consistent with the rate of re-borrowing for other months for the organisation when it was business as usual and is not specific for this period when there was a switch to joint liability lending.

8. Borrowers have the option of paying more than the instalment amount due in any month. It is possible that they do not trust themselves with any extra money that they may have so preferred to overpay.

9. Results available on request.

10. The t-test on the mean difference has a value of −15.38.

11. The sample decreased to 7,128 borrowers, and the t-test on the mean difference has a value of −13.86.

12. Feigenberg et al. (2013), Feigenberg, Field, Pande, Rigol and Sarkar (2014), Field and Pande (2008).

13. Borrowers have to be from the same neighbourhood and preferably live not farther away than one lane from each other.

14. Full sample here refers to the borrowers who we observe taking out a loan under both individual and joint liability.

15. Possible reasons for this might be that the borrower has several SIMs or a switch in the network used. Within the income group under study, these are common practices.