Do microloans induce performance of traditional-loans? Evidence from borrowers of Grameen and similar banks

Abstract

Timely access to bank loans is essential for undertaking economic activities in most developing countries, especially where bond and stock markets are weak and immature. Financial institutions’ ability to provide such loans depends on the scheduled recovery of previously issued loans. However, in most developing countries, including Bangladesh, the scheduled recovery of traditional loans—the key indicator of loan performance—is often dismal. By contrast, the recovery rate of microloans has been highly satisfactory. This apparent paradox warrants a study to determine whether microloans facilitate the recovery of traditional loans, particularly, whether microloans enhance the financial ability of borrowers and allow them to repay both types of loan more frequently than those who take only traditional loans. Using household level micro data on borrowers who took both microloans and traditional loans in Bangladesh, this analysis tested several hypotheses, including whether microloans increased borrowers’ “ability to repay traditional loans,” and whether recovery rates were higher in regions with a higher percentage of people with both types of loan, compared with regions where traditional loans predominate. Regression analysis of loan recovery was conducted using a set of control variables—such as collaterals, the amount of traditional loans, and the interest rate on traditional loans—to assess the effect of microloans taken by a household on the repayment of households’ traditional loans. The study derived additional control variables and examined the robustness of the estimators. Findings reveal that microloans improved the performance of traditional loans. In fact, households with a larger number, as well as amount, of microloans were more capable of repaying traditional loans. Furthermore, microloans had a positive externality effect on other borrowers in a region—the higher the number of microloans taken by a region’s households along with traditional loans, the higher the recovery rate of traditional loans. Close monitoring of loans, in particular, was found to play a greater role in the success of a loan than collateralization. Providing guidelines, educating borrowers, and adequate monitoring are the key policy implications of this study. In sum, more emphasis should be given to monitoring to ensure the proper utilization of traditional loans, rather than merely relying on collateral to improve the performance of these loans.