Expanding access to commercial credit is a key ingredient of development strategiesworldwide. There is less consensus on the role of consumer credit, particularly when extended at high interest rates. Popular skepticism about “unproductive” and “usurious” lending is fueled by academic work highlighting behavioral biases that induce overborrowing. We estimate the impacts of expanding access to consumer credit at 200% APR using a field experiment and follow-up survey and administrative data. The randomly assigned marginal loans produced significant net benefits for borrowers across a wide range of outcomes. There is also some evidence that the marginal loans were profitable.
Information asymmetries are important in theory but difficult to identify in practice. We estimate the presence and importance of hidden information and hidden action problems in a consumer credit market using a new field experiment methodology. We randomized 58,000 direct mail offers to former clients of a major South African lender along three dimensions: (i) an initial “offer interest rate” featured on a direct mail solicitation; (ii) a “contract interest rate” that was revealed only after a borrower agreed to the initial offer rate; and (ii) a dynamic repayment incentive that was also a surprise and extended preferential pricing on future loans to borrowers who remained in good standing. These three randomizations, combined with complete knowledge of the lender's information set, permit identification of specific types of private information problems. Our setup distinguishes hidden information effects from selection on the offer rate (via unobservable risk and anticipated effort), from hidden action effects (via moral hazard in effort) induced by actual contract terms. We find strong evidence of moral hazard and weaker evidence of hidden information problems. A rough estimate suggests that perhaps 13% to 21% of default is due to moral hazard. Asymmetric information thus may help explain the prevalence of credit constraints even in a market that specializes in financing high-risk borrowers.
In the developing world, access to small, individual loans has been variously hailed as a povertyalleviation tool – in the context of “microcredit” – but has also been criticized as “usury” and harmful to vulnerable borrowers. Prior studies have assessed effects of access to credit on traditional economic outcomes for poor borrowers, but effects on mental health have been largely ignored.
Information asymmetries complicate financial relationships. They give rise to problems that force lenders, for example, to rely on contracts that are secondbest solutions both from their own and from borrowers’ perspectives. But while these problems, namely adverse selection and moral hazard, are important in theory, they are difficult to identify and disentangle in practice. Researchers Dean Karlan and Jonathan Zinman take up the challenge with an innovative research methodology. Using an experimental design that randomizes along three dimensions and working with a South African lender, the study isolates the effects of adverse selection and moral hazard, finding strong evidence of moral hazard and weaker evidence of adverse selection on hidden information.
Policymakers often prescribe that microfinance institutions increase interest rates to eliminate their reliance on subsidies. This strategy makes sense if the poor are rate insensitive: then microlenders increase profitability (or achieve sustainability) without reducing the poor's access to credit. We test the assumption of price inelastic demand using randomized trials conducted by a consumer lender in South Africa. The demand curves are downward sloping, and steeper for price increases relative to the lender's standard rates. We also find that loan size is far more responsive to changes in loan maturity than to changes in interest rates, which is consistent with binding liquidity constraints.
Research has shown that advertising exposure and intensity can impact whether or not a consumer buys a product, but outside the laboratory very little is known about what affect the so-called ‘creative content’ of ads has on consumer demand. Nor do we know much about how important the effect of ad content is relative to that of price. In order to better understand these impacts, researchers developed a field study that varies both advertising content and price in the same setting. This method allows us first toexamine whether ad content affects consumer decisions, then to estimate how much it impacts demand relative to the effect of price. Researchers explore these questions with a South African “cash loan” lender and find that ad content has significant effects on demand, as well as some evidence that the impact of ad content is large relative to that of price.