On June 13, ISET hosted Dr. Dmitry Shapiro from the University of North Carolina at Charlotte, who presented his paper “Microfinance and Dynamic Incentives”.
The presenter started his presentation by providing some numbers related to microfinance organizations, explaining the essence of how they work and providing examples of problems that these organizations face, such as: adverse selection, moral hazard, the lack of collateralizable assets, the lack of enforcement and high costs. In the presence of such problems, repayment rates were very low and heavy subsidization was needed. One solution to this is the use of dynamic incentives, which is the methodology used by microfinance organizations throughout the world. According to this methodology, borrowers have incentives to repay in order to have access to higher future loans. This successful methodology is one that does not create incentives to default.
After explaining the ideas underlying the problem, Dr. Shapiro presented his model of dynamic incentives, in which lenders are uncertain about the extent to which borrowers value their future loans. In the model, loan terms are determined endogenously, and loans become more favorable as the probability of default becomes lower. After listing all of the assumptions, the presenter began to derive the equilibrium of the model, which proved to be no easy task. As the equilibrium depends on the probability of repayment in the initial period, different equilibriums can be reached. It appears that in all but one equilibrium all borrowers default after some time–including the most patient ones. In other words, regardless of how they value access to future loans, borrowers will sooner or later decide not to pay it back. He then ended his presentation by considering equilibriums for the cases when group loans and borrowing from different lenders were allowed.
The seminar concluded with a question and answer session. ISET would like to thank Dr. Shapiro for delivering an interesting and useful presentation to the ISET community.
