Determinants of Moral Hazard in Microfinance: Empirical Evidence from Joint Liability Lending Programs in Malawi

Moral hazard is widely reported as a problem in credit and insurance markets, mainly arising from information asymmetry. Although theorists have attempted to explain how group lending with joint liability can be an important tool for mitigating moral hazard among the poor, empirical studies are rare and sometimes give mixed results. In Malawi, for example, although, group lending with joint liability has been practiced for nearly four decades, the unwillingness to repay loans remains the single major cause of default. This paper examines the extent of occurrence of moral hazard and investigates its determinants of occurrence among joint liability lending programs from Malawi, using group level data from 99 farm and non-farm credit groups. Results reveal that peer selection, peer monitoring, peer pressure, dynamic incentives and variables capturing the extent of matching problems explain most of the variation in the incidence of moral hazard among credit groups. The implications are that joint liability lending institutions will continue to rely on social cohesion and dynamic incentives as a means to enhancing their performance which has a direct implication on their outreach, impact and sustainability.moral hazard; joint liability; dynamic incentives; group lending; Malawi

Is Adverse Selection Relevant? Spence-Mirlees Meets the Tunisian Peasant

In the standard problem of mechanism design under adverse selection, it is well known that the transfer function from the principal to the agent will be increasing in the agent's unknown productivity when there exists an incentive compatible mechanism. Cost-sharing contracts in LDC agriculture are a particularly interesting form of such mechanisms. In this paper, we develop a simple model of cost sharing contracts and construct a measure of potentially unobservable household productivity by estimating a plot level production function with household-specific fixed effects, which are then purged of observable household characteristics. We then use the implications of the model and our measure of potentially unobservable tenant productivity to test whether the productivity of tenants is indeed unobservable to landlords. Our empirical results strongly suggest that adverse selection concerns are not empirically important : in the Tunisian village we consider, it would appear that peasants do much better than is expected by Spence and Mirlees.empirical methods, economic development, adverse selection, Mechanism design

Determinants of Moral hazard in Microfinance: Empirical Evidence from Joint Liability Lending Schemes in Malawi

Moral hazard is widely reported as a problem in credit and insurance markets, mainly arising from information asymmetry. Although theorists have attempted to explain the success of Joint Liability Lending (JLL) schemes in mitigating moral hazard, empirical studies are rare. This paper investigates the determinants of moral hazard among JLL schemes from Malawi, using group level data from 99 farm and non-farm credit groups. Results reveal that peer selection, peer monitoring, peer pressure, dynamic incentives and variables capturing the extent of matching problems explain most of the variation in the incidence of moral hazard among credit groups. The implications are that Joint Liability Lending institutions will continue to rely on social cohesion and dynamic incentives as a means to enhancing their performance which has a direct implication on their outreach, impact and sustainability.moral hazard, joint liability, dynamic incentives, group lending, Malawi, Financial Economics,

Microfinance Games

Microfinance has been heralded as an effective way to address imperfections in credit markets. From a theoretical perspective, however, the success of microfinance contracts has puzzling elements. In particular, the group-based mechanisms often employed are vulnerable to free-riding and collusion, although they can also reduce moral hazard and improve selection. We created an experimental economics laboratory in a large urban market in Lima, Peru and over seven months conducted eleven different games that allow us to unpack microfinance mechanisms in a systematic way. We find that risk-taking broadly conforms to predicted patterns, but that behavior is safer than optimal. The results help to explain why pioneering microfinance institutions have been moving away from group-based contracts. The work also provides an example of how to use framed field experiments as a methodological bridge between laboratory and field experiments.microfinance, group lending, information asymmetries, contract theory, experimental economics

Incorporating Insurance Provisions in Microfinance Contracts: Learning from Visa®?

microfinance, insurance, reputation

Microfinance games

Microfinance has been heralded as an effective way to address imperfections in credit markets. But from a theoretical perspective, the success of microfinance contracts has puzzling elements. In particular, the group-based mechanisms often employed are vulnerable to free-riding and collusion, although they can also reduce moral hazard and improve selection. The authors created an experimental economics laboratory in a large urban market in Lima, Peru and over seven months conducted 11 different games that allow them to unpack microfinance mechanisms in a systematic way. They find that risk-taking broadly conforms to predicted patterns, but that behavior is safer than optimal. The results help to explain why pioneering microfinance institutions have been moving away from group-based contracts.Banks&Banking Reform,Insurance&Risk Mitigation,Financial Intermediation,Social Accountability,Civic Participation and Corporate Governance

Microfinance Games

Microfinance has been heralded as an effective way to address imperfections in credit markets. From a theoretical perspective, however, the success of microfinance contracts has puzzling elements. In particular, the group-based mechanisms often employed are vulnerable to free-riding and collusion, although they can also reduce moral hazard and improve selection. We created an experimental economics laboratory in a large urban market in Lima, Peru and over seven months conducted eleven different games that allow us to unpack microfinance mechanisms in a systematic way. We find that risk-taking broadly conforms to predicted patterns, but that behavior is safer than optimal. The results help to explain why pioneering microfinance institutions have been moving away from group-based contracts.Microfinance, Group Lending, Information Asymmetries, Contract Theory, Experimental Economics

Key Factors of Joint-Liability Loan Contracts: An Empirical Analysis

We empirically examine the efficacy of various incentives of microlending contracts such as joint-liability or group access to future loans. We find that joint liability induces a group formation of low risk borrowers. Furthermore, the incentive system leads to peer measures between the borrowers, helping the lender to address the moral hazard and enforcement problem. We also demonstrate that the mechanism realizes high repayment rates, if the loan officers fulfill their complementary duties in the screening and enforcement process. Finally, we show that dynamic incentives have to be restricted if the two problems of joint-liability are to be tackled notably. --