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Enforcing Repayment: Social Sanctions versus Individual Incentives

Arup Daripa

No 1509, Birkbeck Working Papers in Economics and Finance from Birkbeck, Department of Economics, Mathematics & Statistics

Abstract: We study repayment incentives generated through social sanctions and under pure in- dividual liability. In our model agents are heterogeneous, with differing degrees of risk aversion. We consider a simple setting in which agents might strategically default from a loan program. We remove the usual assumption of exogenous social penalties, and consider the endogenous penalty of exclusion from an underlying social cooperation game, modeled here as social risk-sharing. For some types of agents social risk-sharing can be sustained by the threat of exclusion from this arrangement. These types have social capital and can be given a loan that bootstraps on the risk-sharing game by using the threat of exclusion from social risk-sharing to deter strategic default. We show that the use of such sanctions can only cover a fraction of types participating in social risk sharing. Further, coverage is decreasing in loan duration. We then show that an individual loan programaugmented by a compulsory illiquid savings plan (such schemes are used by the Grameen Bank) can deliver greater coverage, and can even cover types excluded from social risk-sharing (i.e. types for whom social penalties are not available at all). Further, the coverage of an individual loan program has the desirable property of increasing with loan size as well as loan duration. Finally, we show that social cooperation enhances the performance of individual loans. Thus fostering social cooperation is beneficial under individual liability loans even though it has limited usefulness as a penalty under social enforcement of repayment. The results offer an explanation for the Grameen BankÂ’s adoption of individual liability replacing group liability in its loan programs since 2002.

Keywords: Strategic default; social cooperation; social penalties; individual liability; loan coverage; loan duration; loan size. (search for similar items in EconPapers)
JEL-codes: O12 (search for similar items in EconPapers)
Date: 2015-03
New Economics Papers: this item is included in nep-ban, nep-cbe, nep-cdm, nep-mfd, nep-mic and nep-soc
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https://eprints.bbk.ac.uk/id/eprint/15270 First version, 2015 (application/pdf)

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