Can joint-liability microcredit help to share entrepreneurial risks? Insights from Mongolia
May 18, 2021
The past decade has witnessed an intense debate about whether microcredit can lift people out of poverty. Experimental evidence from a variety of countries has fueled skepticism around the efficacy of microcredit, showing how access to microloans often does not lead to meaningful increases in income or consumption for poor households. One explanation may be that relatively few people take up microcredit when it is made available to them, for example, because they are dissatisfied with some contractual features.
Microcredit contracts differ in various ways. An important question is therefore whether and how microcredit can become a more attractive – and hence possibly more effective – tool to increase entrepreneurship and living standards. Recent evidence suggests that small design changes such as the introduction of grace periods, ex post repayment flexibility, or repayments that are ex ante tailored to individual needs may affect how people use microcredit and the impacts it has on various outcomes.
The joint liability model
A quintessential feature of microcredit contracts is their liability structure. In the early days of its existence, much attention was given to microcredit contracts in which borrowers form small groups that are jointly liable for repayment. Group members are treated as being in default when at least one of them fails to repay, effectively denying all members access to subsequent loans. This feature was supposed to improve loan performance and raise repayment rates, hence reducing the lender’s risk. The fact that joint-liability loans can also have a risk-sharing aspect for the borrowers has received less attention. In recent work (Attanasio, Augsburg, and De Haas 2019), we focus on this aspect of risk sharing, as it can possibly increase loan take up in situations where projects are risky and where uncertainty is a salient component of entrepreneurial decisions.
Our main hypothesis is that joint liability might encourage (and provide an institutional setting that allows for) risk sharing among group members, as, de facto, it reduces the amount of risk involved in a given project. Joint liability may therefore lead to an increase in the proportion of borrowers that start a business, compared with individual-liability microcredit. To formalise this intuition, we develop a simple theoretical model where individuals choose whether to take up a loan for a risky project or to pursue a safe project. The model produces two main testable predictions. First, individuals are more likely to take up a loan when offered a joint-liability contract instead of an individual-liability one. Second, although in both contractual frameworks take-up rates go down with the risk of the project, this effect is muted for joint-liability contracts.