When you think of applied economics, fun and games might not be the first thing that comes to mind. But a recent study did just that – it used games to look at whether different lending models (individual vs. group, for example) led to safe or risky investments by microentrepreneurs, and lower or higher rates of default on their microloans.

Why does this matter?
Contrary to popular belief (and possibly some wishful thinking), research last year showed that microcredit might not cause businesses to grow much, if at all. A new paper looks at how different methods of providing microloans encourage or discourage microentrepreneurs from taking risks that could yield “transformative” growth.

Microfinance Games, by Xavier Giné, Pamela Jakiela and FAI’s Dean Karlan and Jonathan Morduch documents the findings from research carried out in an experimental economics lab in a large urban market in Lima, Peru. The researchers simulated real microfinance transactions with real microentrepreneurs, to interesting results – even surprising to some. 

Group lending it is
The researchers found that making the availability of future loans contingent on repayment of a current loan was a major factor in dampening the borrower’s appetite for risk. Then, in contrast to many of the predictions from theoretical work on microfinance, it’s group lending that increases rates of risky investment – “risky” being a positive thing in terms of potential for growth. This was particularly true when like-minded groups of microentrepreneurs were allowed to form their own groups.

What’s more, borrowers who would favor low-risk, low-return investments on their own, switch to risky investments when part of a group that includes more intrepid partners. Group lending also saw lower default rates, because group members must bail each other out when luck is bad.

These results contradict the recent industry trend toward individual lending – food for thought?