Liquidity defaults and progressive lending in microfinance: A lab‐in‐the field experiment in Bolivia

• Published date: 01 November 2021
• Author: Francesco Cecchi,Tinka Koster,Robert Lensink
• Date: 01 November 2021
• DOI: http://doi.org/10.1111/rode.12807

Rev Dev Econ. 2021;25:2013–2030.

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2013

wileyonlinelibrary.com/journal/rode

Received: 18 May 2019

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Revised: 19 October 2020

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Accepted: 24 May 2021

DOI: 10.1111/rode.12807

REGULAR ARTICLE

Liquidity defaults and progressive lending in

microfinance: A lab- in- the field experiment in

Bolivia

FrancescoCecchi1

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TinkaKoster2

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RobertLensink1,3

This is an open access article under the terms of the Creat ive Commo ns Attri butio n- NonCo mmerc ial- NoDerivs License, which permits use and

distribution in any medium, provided the original work is properly cited, the use is non- commercial and no modifications or adaptations are

made.

© 2021 The Authors. Review of Development Economics published by John Wiley & Sons Ltd.

1Development Economics Group,

Wageningen University, Wageningen, The

Netherlands

2Wageningen Economic Research,

Wageningen Research, Wageningen, The

Netherlands

3Faculty of Economics and Business,

University of Groningen, Groningen, The

Netherlands

Correspondence

Robert Lensink, Development Economics

Group, Wageningen University,

Hollandseweg 1, 6701 KN Wageningen,

The Netherlands.

Email: b.w.lensink@rug.nl

Abstract

Many microfinance institutions (MFIs) use dynamic incen-

tives in combination with progressive lending schemes to

reduce defaults. However, the specific role of progressive

lending has never been tested empirically, while observa-

tional evidence in other contexts points to potentially ad-

verse effects. Using an experimental approach, we study the

impact of progressive lending on overborrowing, attending

to the possibility that progressive lending may actually in-

crease liquidity defaults. We organize a framed field experi-

ment in the municipality of Coroico, Bolivia, inviting 271

members of an MFI to participate in an experimental game.

In Bolivia, the penetration rates of microfinance are among

the highest in the world, progressive lending systems are

a common practice, and the concept and practices of mi-

crofinance are well known among most people. We find

that participants who borrowed over multiple rounds with

progressively increasing borrowing caps showed increased

liquidity defaults once the caps became unconstraining

compared to those without progressive lending. We specu-

late that this result stems from anchoring borrowing loan re-

quests on the credit limit set by the lender and formalize this

rationale in a model for credit demand and naive borrowers.

2014

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CECCHI Et al.

1

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INTRODUCTION

Progressive lending systems— in which credit limits increase over time conditional on full repayment

of previous loans— are one of the most popular instruments that microfinance institutions (MFIs) cur-

rently use to get around enforcement problems (Herring & Musshoff, 2017). Also known as “stepped”

lending, this system often functions in combination with dynamic incentives, in the form of threats

not to refinance defaulting borrowers. The growing popularity of progressive lending systems among

MFIs is based on theoretical analyses, suggesting that progressive lending may help to reduce strategic

defaults if the threat of no further financing is credible (Armendáriz & Morduch,2000, 2010; Diagne

etal.,2000; Egli,2004; Ghosh & Ray,2001). However, whereas these theoretical models suggest the

positive effects of progressive lending systems, empirical evidence confirmed that a “stepped” lending

system does indeed reduce defaults, which is very scant.1 In other contexts, such as that of credit cards

and consumer borrowing, the potential adverse effect of anchoring to borrowing and repayment limits

on indebtedness has instead been widely shown (e.g., Gross & Souleles,2002; Keys & Wang, 2019;

Soman & Cheema,2002; Stewart,2009). If microfinance borrowers anchor to progressively increas-

ing lending limits, the effect on overborrowing (and thus involuntary liquidity defaults) may at some

point trump the expected beneficial effect on strategic defaults.

This paper contributes to the microfinance literature by presenting the first experimental analysis

to probe the impact of progressive lending on defaults. In particular, we organized a lab- in- the- field

experiment in Bolivia to gauge the effects of progressive lending in a microfinance context, inviting

271 members of a microfinance organization across 12 rural communities in the Coroico municipality

to participate. As an experimental setting, Bolivia is ideal, because the country features some of the

highest microfinance penetration rates in the world (Schipani,2012), with progressive lending sys-

tems as common practice, and widespread familiarity with the concept and practices of microfinance

among its population, including the participants in our games. Nonperforming loans in the Bolivian

microfinance sector hover between 1% and 4% of the total loan portfolio (Heng,2015), but no infor-

mation is available to determine which portion of those is due to strategic decisions by the borrower

and what instead was caused by overborrowing or unanticipated negative economic shocks.

Our analysis reveals that progressive lending may indeed increase liquidity defaults. Interestingly,

our results also suggest that progressive lending, with stepwise increasing credit limits, is inferior to a

system with constant, high, credit limits. We further present a formal model arguing that progressive

lending will increase liquidity defaults if the increasing credit limit set by the MFI in different loan cy-

cles is not in line with actual future repayment possibilities of the borrower, but the borrower's current

demand for microcredit is partially determined by it (i.e., anchoring). This is especially problematic

if the borrower gains increasing confidence in the credit limits set by MFIs as a predictor of his or

MFIs should consider the potential perverse anchoring ef-

fects of progressive lending when designing policies aimed

at reducing overborrowing.

KEYWORDS

lab- in- the- field experiment, microfinance, progressive lending

JEL CLASSIFICATION

G2; G21