Group – Lending Revisited Lecture # 19 Week 12

Structure of this class Emphasis on “trust” and social capital Some basic concepts and definitions Is there a link between trust and overcoming market failure? - Institutional setting and data - Determinants of behavior in the games - Predicting financial decisions Concluding comments

Is there a link between trust and overcoming market failures? The setting: - FINCA – Peru: A village banking organization - FINCA borrowers from Ayacucho, Peru - FINCA provides loans to groups of 30 women, and encourages those women to save. Loans provided under GLJR. Weekly meetings to make loan repayments and savings (compulsory and voluntary) -FINCA employers explicitly encourage to develop solidarity both to enhance their social c

Emphasis on trust and social capital So far: Group lending can potentially overcome adverse selection, moral hazard, and enforcement However: The pioneering work by Karlan (2005) suggests that while group – lending methodologies can be viewed as a Trust game where repayment of a loan is driven by “social pressure”, Trust game alone cannot measure the degree of “trustworthiness” or social capital. If trustworthiness can indeed be created, group lending MFIs can make an important contribution to solve market failures.

Some basic concepts and definitions Social capital: social skills and networks that enable an individual to overcome imperfect information problems and form contracts with others Trust game: Conducted between two players and an administrator. It intends to measure how much one player (A) trusts another player (B), and how trustworthy player B is with respect to player A General Social Surveys (GSS): Surveys on trust, fairness, and helping others. Help to analyze how such measures correlate with “real financial outcomes”, I,e., repayment rates

Is there a link between trust and overcoming market failures? The setting and data: - FINCA – Peru: A village banking organization - FINCA borrowers from Ayacucho, Peru - FINCA provides loans to groups of 30 women, and encourages those women to save. Loans provided under GLJR. Weekly meetings to make loan repayments and savings (compulsory and voluntary) -FINCA employers explicitly encourage to develop solidarity both to enhance their social capital, as well as to monitor and enforce loan repayment Data: a) Individual surveys conducted privately, b) individual surveys conducted publicly, and c) financial savings and loan data

The game: - Participants receive 3 Nuevos Soles - Paired randomly - Assigned randomly to be As (Trust), and Bs (Trustworthy) -As and Bs can identify but not communicate -As given the opportunity to pass 1, 2, or 3 of their coins to Bs -Bs can pass back any number of coins to As What predicts the behavior of players A and B? Y i = α+ β 1 X i + β 2 P i + β 3 G i + ε i

Individual and Pair characteristics Cultural considerations When both individuals are indigenous, Player A passes 24 % more, but Player Bs behavior is the same (gives back same amount regardless of Western or indigenous. Cultural affinity is asymmetric. Geographical considerations Player A passes 9% more to Player B if B lives within 10 min walk. The further away B lives from A, the less B gives back to A. Fear of reprisal.

Common bond Player A passes 20% more to Player B if both attend the same church. Being in the same group Part of the sample was in separate lending and savings group, which enable the researcher to test for this. Being in the same group means more interaction with your partner. Finding: statistically insignificant Instances of borrowing directly Risk – taking plays a significant role for As, not trust

Group effects Player A passes more when Player B is more similar culturally and lives closer to the others in the lending group. Player B passed more back to Player A when player A was similar (culturally) to others in the group Indigenous players get more passed to them and western players get less passed on to them

Now, what happens if Bs do not get a pass? -When Bs are culturally dissimilar -When Bs are Westerns -When Bs have never borrowed from other members (outside the FINCA credit contracts) We now turn to “Public Goods Game” Y i = α+ β 1 X i + β 3 G i + ε i Where Y i is 1 if the player contributed to the public good and 0 otherwise

Findings More likely to contribute when individuals (As) pass More likely to contribute when borrowing outside the FINCA program from other members Less likely to contribute if individuals live farther from the group Individuals less likely to contribute if have not attended church recently Less likely to contribute individuals are Westerns More likely to contribute if answer the GSS questions

Predicting financial decisions When Bs are trustworthy, less defaults When As trust more, they save less, and drop out easily. Why? Take bad risks or make bad investments

Concluding comment Prior literature suggests that it measures trust by player A, and trustworthiness by player B Karlan finds evidence that Player A measures propensity to take risks. But it also shows that trust as measured by cultural affinity, living near their partner, and attending the same church lead to higher passes by Player A. Q: Can group-lending methodologies create trust and/or social capital? -  Next Class: Paper by Guiné and Karlan (2006) on the Philippines