Microfinance and Dynamic Incentives

29 Pages Posted: 3 Sep 2008 Last revised: 11 Sep 2012

See all articles by Dmitry Shapiro

Dmitry Shapiro

Department of Economics, Seoul National University

Date Written: September 10, 2012

Abstract

Dynamic incentives, where incentives to repay are generated by granting access to future loans, is one of the practices used by microfinance institutions (MFIs) to ensure high repayment rates. In this paper, I present a model of dynamic incentives where lenders are uncertain over how much borrowers value future loans. Such information asymmetry can arise if lenders are uncertain about borrowers' outside options, their patience or the rate of productivity growth. Loan terms are determined endogenously and loans become more favorable as probability of default becomes lower. The main result of the paper is that in all equilibria but one all borrowers default including the most patient ones. The paper highlights limitations of dynamic incentives as well as risks that could arise from exclusive reliance on them.

Keywords: Microfinance, dynamic incentives, lender-borrower dynamic, strategic default, unsecured credit

JEL Classification: C73, D82, O12, O16

Suggested Citation

Shapiro, Dmitry, Microfinance and Dynamic Incentives (September 10, 2012). Available at SSRN: https://ssrn.com/abstract=1260825 or http://dx.doi.org/10.2139/ssrn.1260825

Dmitry Shapiro (Contact Author)

Department of Economics, Seoul National University ( email )

San 56-1, Silim-dong, Kwanak-ku
Seoul 151-742

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