Risks, Returns, and Relational Lending: Personal Ties in Microfinance

Personal relationships often facilitate credit transactions. However, existing research provides different expectations about whether personal ties prove detrimental or beneficial for lenders. Economic sociology highlights the advantages lenders accrue when they have personal ties with borrowers. Yet research from social psychology suggests that personal ties can be costly because lenders may “escalate commitment” to poor performers. This study uses data from a microfinance bank to ask, When are personal relationships detrimental or beneficial for lenders? It shows that lenders with personal ties to borrowers are less likely to cut those ties and their borrowers miss fewer payments. However, these trends vary with frequency of contract. When lenders and borrowers interact infrequently, lenders continue to show strong commitment, but borrowers become less compliant, creating potential problems for lenders. This study integrates theories from economic sociology and social psychology to offer a more nuanced, temporally informed understanding of personal ties in finance.