Centre for Development Economics
and
Department of Economics, Delhi School of Economics
ANNOUNCE A SEMINAR
A Theory of Progressive Lending
by
Dyotona Das Gupta
(Delhi School of Economics)
Thursday, February 20, 2020, at 3:05 P.M.
Venue: New Seminar Room (Room no. 116, First Floor)
Department of Economics, Delhi School of Economics
All are cordially invited
Abstract
Microfinance Institutions (MFIs) lend to poor clients without any collateral, using a strategy of progressive lending where borrowers are eligible to borrow more in the future, conditional on repaying current loans. This helps sustain high repayment rates. We develop a theory of such progressive lending, extending a standard Ramsey growth model of a representative agent to incorporate dynamic repayment incentives. The agent has an exogenous initial wealth, preferences for smoothing consumption over time, access to a concave production technology in autarky and is able to save at an interest rate equal to the rate of time discount. The associated problem of default (well known since Bulow-Rogoff (1989)) is overcome by bundling the loan contract with `aid’ provided by the MFI which raises the borrower’s productivity, conditional on past repayment. We characterize the optimal dynamic contract which maximizes the agent’s payoff, subject to a breakeven constraint for the MFI, and show it involves progressive lending where the borrower never defaults on the equilibrium path. For agents with initial wealth above a critical threshold, the first-best is sustainable with a stationary contract. For other poorer agents, there is perpetual but shrinking underinvestment which tends to disappear in the long run: their loan sizes, investments and wealth grow over time eventually approaching the levels for the agent at the first-best threshold. The gaps in production and wealth between rich and poor agents narrow over time, but full long-run convergence does not obtain: those with initial wealth above the threshold remain wealthier in the long run. Poor agents with higher impatience or preferences for consumption smoothing experience slower growth.