Moral Hazard, Peer Monitoring, and Microcredit: Field Experimental Evidence from Paraguay

Given the substantial amount of resources currently invested in microcredit programs, it is more important than ever to accurately assess the extent to which peer monitoring by borrowers faced with group liability contracts actually reduces moral hazard. We conduct a field experiment with women about to enter a group loan program in Paraguay and then gather administrative data on the members’ repayment behavior in the six-month period following the experiment. In addition to the experiment which is designed to measure individual propensities to monitor under incentives similar to group liability, we collect a variety of the other potential correlates of borrowing behavior and repayment. Controlling for other factors, we find a very strong causal relationship between the monitoring propensity of one’s loan group and repayment. Our lowest estimate suggests that borrowers in groups with above median monitoring are 36 percent less likely to have a problem repaying their portion of the loan. Besides confirming a number of previous results, we also find some evidence that risk preferences, social preferences, and cognitive skills affect repayment. JEL Classifications: C93, D03, D14, G21, O16, O54 Jeffrey Carpenter is a professor in the department of economics at Middlebury College and a visiting scholar at the Federal Reserve Bank of Boston. His e-mail address is [email protected]. Tyler Williams is a graduate student in the department of economics at the Massachusetts Institute of Technology. His e-mail address is [email protected]. This paper, which may be revised, is available on the web site of the Federal Reserve Bank of Boston at http://www.bos.frb.org/economic/wp/index.htm. We thank Mary Burke, Ben Feigenberg, Julian Jamison, and Elizabeth Murry for valuable comments. The views expressed in this paper are those of the author and do not necessarily represent those of the Federal Reserve Bank of Boston or the Federal Reserve System. This version: June 28, 2010 Research Center for Behavioral Economics