Long-term relationship and Reciprocity in Credit Market Experiment: Implications for Microfinance

Microfinance sector is generally associated with high repayment rates. However it is not clear whether such success only results from the use of peer lending or is due to the existence of a long-term relationship between the borrower and her incumbent lender – that also strongly characterizes microcredit reality. Our paper contributes to the existing literature on microcredit market by experimentally examining to what extent long-term lending relationship enables to mitigate moral hazard associated with repayment and project selection in the absence of peer group. Subsequently, the aim of this paper is to investigate to what extent reciprocity and reputation can enhance credit market performance by mitigating moral hazard. The originality of our research lies in the fact that we introduce variability in socio-demographic characteristics by recruiting "real people", including not only students that are typically viewed as the standard subject pool but also bankers both from classical banking and from microcredit institutions. Consistent with previous studies, our findings reveal that the opportunity to engage bilateral long-term relationships strongly improves the market performance by mitigating the repayment problem (ex-post moral hazard) and thus enhancing cooperation between borrowers and lenders. This fact seems to highlight the prominence of reputation as a disciplining devise that conducts selfish borrowers to behave reciprocally. Notwithstanding, our results also seem to indicate that lenders take advantage of their long-term situation by increasing their rates. Credit cost is significantly higher under the partner treatments than under the stranger treatment. As a consequence, the borrowers may be incited to take more risk to reimburse their loan (ex-ante moral hazard). Improving the information disclosure negligibly enhances cooperation and thus market performance but alters the principals' lending behavioral patterns. Finally, we find that social bankers are more likely to makes fair credit offers to borrowers than classical bankers.