Compulsory versus voluntary savings as an incentive mechanism in microfinance programs

Abstract This paper investigates the incentive mechanism of individual microlending contracts focusing particularly on microsavings. We built a model to show the role of compulsory and voluntary microsavings in addressing problems of information asymmetries. Our results are twofold. First, we show that compulsory savings creates incentive conditions required for allowing micro-entrepreneurs to be financed by a Microfinance institution. Second, we show that voluntary savings can serve as a complementary tool to repayment enforcement at the same time inducing borrowers to reveal abilities of their projects.