Intermediated Loans: A New Approach to Microfinance∗

This paper studies TRAIL, a variation on traditional microfinance, where a microfinance institution appoints local intermediaries (traders or informal moneylenders) as agents to recommend borrowers for individual liability loans. Agents earn commissions that depend on loan repayments. There are no peer monitoring, group meetings or savings requirements. The loans are designed to finance agricultural working capital and so are of longer duration than standard microfinance loans. Borrowers who repay loans are eligible for larger loans in future loan cycles. We develop a model of the credit market with adverse selection, in which borrowers vary with respect to (unobservable) project risk and (observable) landholdings, and the informal credit market is locally segmented. The model generates detailed predictions about informal interest rates, borrower selection, take-up and repayment patterns that vary with respect to both risk and landholding categories. These are successfully tested using data from a randomized evaluation currently being conducted in West Bengal, India. Traditional group-based joint liability loans (GBL) serve as the control. TRAIL generates higher repayment rates, while GBL is more pro-poor. TRAIL also achieves higher take-up rates, suggesting that TRAIL overcomes problems faced by microfinance clients that are inherent in group-based lending.