DP7011 Learning and Microlending

Author(s): Mikhail Drugov, Rocco Macchiavello
Publication Date: October 2008
Keyword(s): Credit Constraints, Group Lending, Microlending Schemes, Savings, Scaling-Up, Self-Discovery
JEL(s): D14, O14, O16
Programme Areas: Financial Economics, Development Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7011

For many self-employed poor in the developing world, entrepreneurship involves experimenting with new technologies and learning about oneself. This paper explores the (positive and normative) implications of learning for the practice of lending to the poor. The optimal lending contract rationalizes several common aspects of microlending schemes, such as "mandatory saving requirements", "progressive lending" and "group funds". Joint liability contracts are, however, not necessarily optimal. Among the poorest borrowers the model predicts excessively high retention rates, the contemporaneous holding of borrowing and savings at unfavorable interest rates as well as the failure to undertake profitable and easily available investment opportunities, such as accepting larger loans to scale-up business. Further testable predictions can be used to interpret and guide the design of controlled field experiments to evaluate microlending schemes.