Microfinance loans increase social distrust among the poor

What is it about?

Microfinance loans can create social frictions, primarily because they are often given to groups of individuals. If a certain member of a borrowing group defaults, her relations with peers—who would force her to pay her share of repayment—may get affected. This can lead to souring of relations and mutual distrust. In this paper, we find that the higher the prevalence of microfinance in a country, the higher are social distrust levels, specifically among the low-income households.

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Photo by Dave Lowe on Unsplash

Photo by Dave Lowe on Unsplash

Why is it important?

Poor households are heavily dependent on social relationships, which serve various economic functions, acting as informal sources of insurance and credit. When cash-strapped and struck by a crisis—e.g., a family member falling ill or a crop failing—they rely on their social circle for loans. Microfinance came with a lot of promise, providing such households with alternative, formal means of credit. But high-interest, group-based loans, which often require even weekly repayments, need extreme financial discipline. If a group member defaults, other members contribute to keep the repayments on track, in the hope of not losing opportunity of getting bigger loans in future from the microfinance institution, but the defaulting member faces the social fallout as other loan-members react. Such social frictions may deprive the credit-constrained poor member of the previously existing informal insurance and credit sources. The pressures to meet strict repayment schedules can make such unreported default common, leading to a higher generalised distrust in communities.

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