Productivity Shocks and Repayment Behavior in Rural Credit Markets: A Framed Field Experiment [book]

Guigonan Serge Adjognon, Lenis Saweda Liverpool-Tasie, Robert Shupp
2018 Policy Research Working Papers   unpublished
3 Improving rural credit markets requires a good understanding of the root 4 causes of market failures and taking necessary steps to address them. This 5 paper investigates the role of productivity shocks in borrowers repayment 6 choices. Using a framed field experiment that simulated a repeated interac-7 tion in an input credit market, the analysis finds strong evidence that adverse 8 productivity shocks lead to higher default, even when they do not induce neg-9 ative returns. This
more » ... s. This relationship is robust to the presence of an information 10 exchange system enforcing dynamic incentives. The findings suggest that 11 recurrent shocks such as those resulting from the harmful effects of climate 12 change could exacerbate failures in rural credit markets, undermining hard-13 won progress toward rural financial inclusion. 14 15 JEL classification: Q14, O16, O13. 16 namic incentives for limiting default risks may be hampered in the presence 44 of productivity shocks affecting the returns to the investments made by the 45 borrower. Productivity shocks may affect repayment behavior through an 46 economic channel by genuinely affecting the borrowers' repayment ability, 47 for example after a net loss. Tedeschi (2006) notes that with dynamic in-48 centives, punishment should only be sufficiently long to prevent a borrower 49 from strategic default, but not so long as to unduly punish the borrower that 50 experiences a negative economic shock. Productivity shocks could also affect 51 default risks through a behavioral channel. As long as the borrower has a 52 concave utility function, repaying after a low return to investments is more 53 costly than repaying after a high return, even when productivity shocks are 54 not important enough to fully impair the ability to repay. Thus increased 55 productivity shocks add another dimension to the default risks in rural credit 56 markets which could reinforce market failures, and is missing from the extant 57 micro-finance literature and debates. 58 59 Drawing from Conning and Udry (2007), we first discuss a simple stylized 60 theoretical model focusing on the impact of shocks on repayment decisions, 61 in the hypothetical settings where farmers were offered access to input credit 62 and had to make repayment decisions after harvest realization. We then 63 implemented an incentivized framed field experiment to test the model pre-64 dictions. We test this under two experimental conditions: one in which the 65 repayment history of each farmer is made available to all the credit suppli-66 ers, thereby facilitating enforcement through dynamic incentives, and one in 67 2. THEORETICAL MODEL AND PREDICTIONS 89 A model of input credit 90 We develop a simple stylized model of repeated input credit iterations 91 between borrowers and lenders in the context of farm input credit. This 92 model builds on elements of the theoretical discussion of rural financial mar-93 kets in Conning and Udry (2007), where the authors described the value of 94 repeated interactions and information sharing as self-enforcing tools for sus-95 taining credit markets. In the model described below, we add the role of 96 negative productivity shocks and explore how they interact with information 97 sharing mechanisms. 98 99 Consider a repeated matching game between a set of agro dealers or bro-100 kers n s = {1, , N s } and a set of farmers n b = {1, , N b } . The farmers need 101 inputs for agricultural production but do not have the capital to pay upfront 102 and thus must rely on credit from the agro dealers. Suppose the agro dealers 103 consider selling on credit in order to maximize the volume of sales. The prob-104 lem is that to do so, they will have to offer uncollateralized input loans to 105 farmers because farmers do not own valuable assets to provide as collateral. 106 At each stage of the game, each agro dealer plays a 2-player sequential stage 107 game with each farmer. First, at the beginning of the agricultural season, 108 the agro dealer decides whether or not to make an offer of input on credit to 109 the farmer. After harvest, conditional on receiving the input on credit, the 110 farmer decides whether to repay or not. Output without using the input is 111 denoted R none but there is a random weather shock η = {Good, Bad} that is 112 realized after the input has been acquired and used. The return to the use of 113 157 with which information about defaulters flows between agro dealers so that 158
doi:10.1596/1813-9450-8528 fatcat:kpy4sio6qveb3pri63lij37ziu