Jonathan Morduch, Xavier Giné, Pamela Jakiela, and Dean Karlan
American Economic Journal: Applied Economics, Vol. 2, No. 3.
Microfinance banks use group-based lending contracts to strengthen borrowers’ incentives for diligence, but the contracts are vulnerable to free-riding and collusion. We systematically unpack micro nance mechanisms through ten experimental games played in an experimental economics laboratory in urban Peru. Risk-taking broadly conforms to theoretical predictions, with dynamic incentives strongly reducing risk-taking even without group-based mechanisms. Group lending increases risk-taking, especially for risk-averse borrowers, but this is moderated when borrowers form their own groups. Group contracts bene t borrowers by creating implicit insurance against investment losses, but the costs are borne by other borrowers, especially the most risk averse.