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VULNERABILITY OF MICROFINANCE TO STRATEGIC DEFAULT AND COVARIATE SHOCKS: EVIDENCE FROM PAKISTAN
Author(s) -
KUROSAKI TAKASHI,
KHAN HIDAYAT ULLAH
Publication year - 2012
Publication title -
the developing economies
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.305
H-Index - 30
eISSN - 1746-1049
pISSN - 0012-1533
DOI - 10.1111/j.1746-1049.2012.00160.x
Subject(s) - microfinance , seriousness , enforcement , incentive , joint and several liability , economics , vulnerability (computing) , covariate , empirical evidence , monetary economics , econometrics , finance , legal liability , liability , microeconomics , political science , economic growth , computer security , epistemology , computer science , law , philosophy
This paper investigates the repayment behavior of borrowers of a Pakistani microfinance institution (MFI) using a unique dataset of approximately 45,000 installment records over the period 1998–2007. In early 2005, the MFI introduced reforms that included improved enforcement of contingent renewal. The reforms led to a healthy situation with almost zero default rates. We hypothesize that strategic default under the joint liability mechanism was encouraged by weak enforcement of contingent renewal and was one of the factors responsible for the pre‐reform failure. To support this hypothesis, we show that before the reforms, a borrower's delay in installment repayment was correlated with other group members' repayment delays beyond the level explained by possible correlation of project failures due to locally covariate shocks. Such excessive correlation disappeared after the reforms, including the period after the 2005 Kashmir earthquake. The empirical evidence thus demonstrates the existence and seriousness of the strategic default under weak dynamic incentives.