Rethinking Microloan Defaults

Microcredit—the distribution of small, uncollateralized but jointly liable loans to the poorest of the poor—has been touted as a powerful approach for combatting global poverty. While some microcredit programs enjoy high repayment rates, others face unsustainably high default rates. Efforts to improve the sustainability of microcredit by reducing default rates have typically focused on increasing the likelihood that individuals repay their share of the loan by applying lessons from social dilemmas research. Here, we argue that defaults are driven more by the response of other group members to delinquent groupmates. Even in the absence of any free-rider problem, some people will be unable to make their payments on any given occasion due to bad luck. It is other group members’ unwillingness to pitch in extra that leads to default. To support this argument, we utilize the Ultimatum Game (UG), behavioral economics’ standard paradigm for measuring one’s aversion to inequitable outcomes. First, we show that country-level variation in microloan default rates is strongly correlated (overall r = 0.81) with country-level UG rejection rates observed in a recent meta-analysis of cross-cultural UG experiments from 13 countries (but not correlated with various measures related to free-riding). We then introduce a laboratory model “Microloan Game,” and present evidence that defaults arise from inequity averse individuals refusing to make up the difference when others fail to pay their fair share. This perspective suggests a suite of new approaches for combatting defaults that leverage findings on reducing UG rejections, rather than deterring free-riding.