Abstract
How do borrowers respond to improvements in a lender's ability to punish defaulters? This paper reports the results of a randomized field experiment in rural Malawi that examines the impact of fingerprinting borrowers in a context where a unique identification system is absent. Fingerprinting allows the lender to more effectively use dynamic repayment incentives: withholding future loans from past defaulters while rewarding good borrowers with better loan terms. Consistent with a simple model of borrower heterogeneity and information asymmetries, fingerprinting led to substantially higher repayment rates for borrowers with the highest ex ante default risk, but had no effect for the rest of the borrowers. The change in repayment rates is driven by reductions in adverse selection (smaller loan sizes) and lower moral hazard (for example, less diversion of loan-financed fertilizer from its intended use on the cash crop).
Highlights
Lending in low-income countries is notoriously difficult
To guide the empirical strategy, we develop a simple two period model in the spirit of Stiglitz and Weiss (1983) that incorporates both adverse selection and moral hazard and show that “dynamic incentives,” that is, the ability to deny credit in the second period based on the first period repayment performance, can reduce both types of asymmetric information problems and raise repayment
We find no effect on loan-take-up by borrowers, perhaps because clubs were formed with the expectation of credit availability and fingerprinting did not act as a strong enough deterrent to borrowing to affect farmers’ decisions at the extensive margin
Summary
Clients typically lack adequate collateral and lenders often have limited information about the profitability of their customers. Information asymmetries coupled with costly enforcement of repayment severely limits the profitability of lenders. All farmers need cash at the same time, so allowing some farmers to borrow only after others have repaid their loans is problematic because some farmers would end up receiving credit when they do not need it. Even if all clients were allowed to borrow at the same time, joint liability may be ineffective if most production shocks are covariate. Perhaps most importantly, lenders may lack the ability to deny access to future loans to defaulting clients in the absence of a national system that allows individuals to be uniquely identified
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