Default risks, moral hazard and market-based solution: Evidence from renewable energy market in Bangladesh

Abstract

This paper analyzes a unique case of default risks associated with a solar homes program in Bangladesh, implemented by the Infrastructure Development Company Limited (IDCOL). Out of 4.3 million solar homes adopter households, about 1.2 million households became default in paying their due payment of the solar home system. We explain the behavior of the customers in a hyperbolic discounting framework where various shocks increase the risks of default. Further we extend the model to explain moral hazard problem under the refinancing program structure in the absence of an optimal contract. For empirical analysis, we apply the Cox’s proportional hazard model to study the factors responsible for default and instantaneous hazard rates. Using primary survey data from 1300 households, we find that various exogenous shocks and financial constraints can explain the default situation of the customers along with a portion of the default customers being adversely selected in the context of moral hazard problem, which is consistent with the prediction of our theoretical model. We propose a market-based solution to the problem by withdrawing subsidies from the program.