Strategic Default in joint liability groups: Evidence from a natural experiment in India

Despite the high repayment rates claimed by microcredit programs around the world, some groups of borrowers eventually default and are subsequently disbanded. Exposure to common shocks and strategic default are reasons for the deterioration in group repayment but identification of the precise mechanism is difficult. In this paper we exploit an announcement issued by the Anjuman Committee of a town in southern India banning all Muslims from repaying their microfinance loans. Using administrative data we find that borrowers in Muslim-dominated groups have higher default rates after the announcement compared to the same borrowers with loans in Hindu-dominated groups. We conclude that strict adherence to joint liability rules may have triggered strategic default that might have been avoided if lenders had allowed more flexibility in repayment. JEL: C81, G21, O12, O16 ∗ Gine: xgine@worldbank.org. Krishnaswamy: karuna.krishnaswamy@gmail.com. Ponce: aponcer@gmail.com. We thank Jordi de la Torre for superb research assistance. We are grateful to David McKenzie, Maitreesh Ghatak, Dean Karlan, Bilal Zia and conference participants at BREAD, GUC in Cairo and the World Bank. The views expressed in this paper are those of the authors and should not be attributed to the World Bank, its executive directors, or the countries they represent.