Digital Collateral

Abstract

A new form of secured lending utilizing “digital collateral” has recently emerged, most prominently in low and middle income countries. Digital collateral relies on “lockout” technology, which allows the lender to temporarily disable the flow value of the collateral to the borrower without physically repossessing it. We explore this new form of credit both in a model and in a field experiment using school-fee loans digitally secured with a solar home system. We find that securing a loan with digital collateral drastically reduces default rates (by 19 pp) and increases the lender’s rate of return (by 38 pp). Employing a variant of the Karlan and Zinman (2009) methodology, we decompose the total effect on repayment and find that roughly one-third is attributable to adverse selection and two-thirds is attributable to moral hazard. In addition, we find that access to digitally-secured school-fee loans significantly increases school enrollment (by 8 pp) and school-related expenditures (by 42%) without detrimental effects to households’ balance sheet.

Keywords: Collateralized Lending, Microfinance, Moral Hazard, Adverse Selection, Education

JEL Classification: G20, I22, O16