| By: |
Arup Daripa (Department of Economics, Mathematics & Statistics, Birkbeck) |
| Abstract: |
We study repayment incentives generated through social sanctions and under
pure in- dividual liability. In our model agents are heterogeneous, with
differing degrees of risk aversion. We consider a simple setting in which
agents might strategically default from a loan program. We remove the usual
assumption of exogenous social penalties, and consider the endogenous penalty
of exclusion from an underlying social cooperation game, modeled here as
social risk-sharing. For some types of agents social risk-sharing can be
sustained by the threat of exclusion from this arrangement. These types have
social capital and can be given a loan that bootstraps on the risk-sharing
game by using the threat of exclusion from social risk-sharing to deter
strategic default. We show that the use of such sanctions can only cover a
fraction of types participating in social risk sharing. Further, coverage is
decreasing in loan duration. We then show that an individual loan
programaugmented by a compulsory illiquid savings plan (such schemes are used
by the Grameen Bank) can deliver greater coverage, and can even cover types
excluded from social risk-sharing (i.e. types for whom social penalties are
not available at all). Further, the coverage of an individual loan program has
the desirable property of increasing with loan size as well as loan duration.
Finally, we show that social cooperation enhances the performance of
individual loans. Thus fostering social cooperation is beneficial under
individual liability loans even though it has limited usefulness as a penalty
under social enforcement of repayment. The results offer an explanation for
the Grameen Bank’s adoption of individual liability replacing group liability
in its loan programs since 2002. |
| Keywords: |
Strategic default, social cooperation, social penalties, individual liability, loan coverage, loan duration, loan size. |
| JEL: |
O12 |
| Date: |
2015–03 |
| URL: |
http://d.repec.org/n?u=RePEc:bbk:bbkefp:1509&r=mfd |