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Impact of Microcredit and Interest Rate Sensitivity – First Valley Bank, First Macro Bank, and FICO Bank, Philippines
Microfinance institutions (MFIs) traditionally rely on committees to screen potential clients for credit. This subjective, case-by-case approach to loan approval is time consuming and unlikely to draw the line of creditworthiness at the most advantageous level for the MFI. For these reasons, MFIs have begun turning to credit scoring as a more systematic and accurate decision mechanism. Credit scoring uses an applicant's business and personal characteristics and history to determine loan approval and can be calibrated to fit a particular financial institution and its clients.
The study involved two levels of randomization. First, 1,000-1,500 potential clients for the bank's individual microcredit loan product received a randomly assigned interest rate offer during a marketing visit. Once an application was submitted, a credit score was calculated based on applicant characteristics. Within a certain score window, loan approvals were randomly approved or denied. The project subsequently analyzed changes in take-up across interest rates, loan repayment rates, and clients' business and household outcomes to measure both client price sensitivity and the impact of the selection process on bank profits and client well being.
Results
The authors find that marginally creditworthy applicants who received loan approval have an increased likelihood of borrowing from the lender or a close substitute, and there is evidence that this contributed to an increase in total formal sector borrowing. There is some evidence that business profits increased for male entrepreneurs, but not for female entrepreneurs, in the treatment group. Households with a male applicant were also more likely to enroll their children in school. Results by income suggest that higher income households in the treatment group also had higher business profits, and potentially higher returns to capital, than lower income households in the treatment group. Interestingly, it seems that profitable businesses achieved higher returns by shedding unproductive workers; treatment households spent less on labor and more on education. They also spent less on formal insurance, suggesting that access to credit is a substitute risk management strategy. The results call into question the rationale behind microcredit targeting women and microentrepreneurs to the exclusion of men and wage earners. These groups' households may benefit just as much, if not more, from their access to credit. The results also highlight the importance of replicating tests and program evaluations across different settings. Innovations for Poverty Action is working towards that goal, and is currently implementing microfinance impact studies in Morocco, Mexico, as well as continuing studies in the Philippines, the first of which will wrap up fieldwork in 2010. The financial behavior of households in developing countries is complex, and further research on the impact of expanding access to credit will allow a deeper understanding of how best to harness microcredit's potential. |
Project Overview
Researchers
Dean Karlan, Jonathan Zinman
Research Areas
Mechanisms Matter, Measuring Impact
Themes
Credit, Interest Rates
Research Questions
How does approval for a microloan impact micro-entrepreneurs’ households and businesses? How do changes in interest rates impact the demand for microloans? How can credit scoring and interest rates be used to optimize MFI profitability through client selection?
Country
Philippines
Sample
Microenterprise owners who apply for a business loan from the partner banks
Status
Complete |
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Research |
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IPA's collaboration with the First Valley Bank, First Macro Bank, and FICO Bank in the Philippines offers an opportunity to test the application of credit scoring - commonly used by banks in developed countries - in the new context of developing country MFIs. The implementation of a systematic loan approval process also allows interest rate offers and approvals within a certain credit score window to be randomized. The study enables greater understanding of how credit scoring and interest rates can be used by rural banks to optimize the profitability of their client selection and also how loan approval and price impact micro-entrepreneurs.