Progressive Lending in Microfinance—What about the Farmers?

Abstract

Dynamic incentives have become a common measure in microfinance institutions (MFI) to counteract the risk of default and to strengthen the borrower's identification with his micro‐lender. This article focuses on progressive lending over the course of the bank–borrower relationship. As the agricultural sector is increasingly important for Azerbaijan's economy, this study differentiates between the lending policies faced by farmers and non‐farmers, and matches the findings with the repayment performances of both client groups. By means of a rich data set spanning from 2007 through 2012 provided by an MFI in Azerbaijan, it can be demonstrated that farmers face a higher degree of loan volume rationing that cannot be justified by our findings on repayment performances. Moreover, we find that repeated borrowing increases the default probabilities of both client groups. In conclusion, we deduce that the MFI and borrowers could benefit from reconsidering the current lending policies.

Relationship lending in microfinance: How does it impact client dropout?

“…Indeed, as argued by Galariotis et al (, page 1379), relationship lending may probably be “the most important financing tool for such opaque borrowers.” MFIs often use a relationship lending technique called “the progressive lending technique” (Hering & Musshoff, ), increasing the credit amount only if the previous loan has been correctly repaid (Armendáriz & Morduch, ). This method acts as a dynamic incentive for clients to repay and thus as a risk mitigation instrument for MFIs (Hering & Musshoff, ). As explained by Schrader (), MFIs using relationship lending have proven to be successful.…”

Liquidity defaults and progressive lending in microfinance: A lab‐in‐the field experiment in Bolivia

“…Progressive lending systems—in which credit limits increase over time conditional on full repayment of previous loans—are one of the most popular instruments that microfinance institutions (MFIs) currently use to get around enforcement problems (Herring & Musshoff, 2017). Also known as “stepped” lending, this system often functions in combination with dynamic incentives, in the form of threats not to refinance defaulting borrowers.…”

“…1 1 The only exception is Herring and Musshoff (2017), who analyze a progressive lending system for farmers and non‐farmers in Azerbaijan and find, in contrast to the theoretical literature, that the repeated borrowing increased defaults of both groups.…”