Financial Services to the Micro, Small and Medium Enterprises

Dean KarlanYale University

Innovations for Poverty ActionstickK.com

Two Themes

• Apply Behavioral Economics to product design

• Find win-win evaluation strategies:– Measure social impact

AND

– Improve operations

Behavioral Economics

Assumptions of Behavioral Economics

• Humans vs. Econs

• Bounded Rationality – including bounded attention

• Bounded Willpower

• Bounded Self-interest

Escalator Lesson

• People are complicated. No one model predicts a person’s behavior.

• Design matters

Suppose you received one of these letters:What would be most important to you?

Direct Mail Lesson

• The “normal” things economists look at aren’t always the drivers.

• Behavioral economics has expanded the standard set of behavior drivers…

Behavioral Economics

• Theoretical behavioral economics:– Tries to understand, develop models, etc. to

predict behavior better (and heterogeneity)

• Applied behavioral economics:– Tries to figure out how to use behavioral

economics to make the world a better place

Nudges

Anyone who designs the environment in which people make choices is a “choice architect”–Menus– Store layouts–Organ donorship– Retirement savings plans

–One last amusing one, and then banking

Urinal, Amsterdam Airport

Applications in Banking

• Commitment contracts– Savings

• Reminds to save– Increased savings by 6% in three country study!

• But also..– Smoking– Weight loss

Goals and Commitment

• Three “truths” for most if not everyone:– You have set goals for yourself in the past.– You have not achieved every one of those goals.– You regret not having achieved some of them.

Commitment Contracts

• Make your vices more expensive• Make your virtues cheaper• The obvious:– Savings– Weight loss– Smoking– Exercise

Philippines: Savings• “SEED” for the Green Bank of

Caraga in Mindanao• Simplest “commitment:” no

withdrawals until goal amount or date is reached

• No increase in interest rates for illiquidity

• 28% opened an account• 300% increase in savings for those

who opened an account• Similar to “Christmas Clubs” in the

USA, popular in the past

Philippine: Smoking

“Committed Action to Reduce and End Smoking”• Minimum deposit of 50 pesos ($1.25)• CARES lock box to help clients save daily• No access to the money in the account for 6

months• No interest-bearing• Weekly deposit collection service (the service

stops if the client fails to deposit for 3 consecutive weeks)

• Must pass a urine test within 1 week of the 6 month maturity date in order to gain access to the money in the account

Philippine Smoking: Results

• 83 out of 781 (11%) individuals offered CARES signed a contract.• 29 of 83 passed at 6 months• Of the 29 who passed at 6 months:• 14 passed and 15 failed at 12 months

• Of the 54 who failed at 6 months:• 7 passed and 47 failed at 12 months

• 30 percentage points more likely to stop smoking

Mexico: Corporate Employee Wellness Program

• Contracts for employees– Lose weight– Stop smoking– Read more– Play more– Complete tasks on time for work

• No financial incentives• But psychological commitment• And public visibility

Behavioral Economics: Conclusions

Humans are imperfect. We need all need help.

We can improve choices without restricting options.

Nudges can work.

Part II: Win-Win for Social Impact

• Many ways to improve programs

• Evaluation, done well– Looks forward, Not backwards– Is an investment, not a cost– Helps improve profits, not merely prove impact

Outline

• Four specific projects to describe– Reminders to save– Small/medium enterprise mentoring/consulting• Mexico

– Price: expanding access to credit• South Africa and Mexico

– Credit scoring to measure impact of loans• Philippines and South Africa

Reminders to Save:Peru, Bolivia & Philippines

• Attention problem: Savings is “salience-disadvantaged” relative to debt

• Do the poor save everything they can? Or does attention to needs influence savings?

• Three country study• Impact: – Increase savings by 6% with monthly reminder– Increased likelihood of reaching goal by 3

percentage points

Mentoring/Consulting Project

• Run by Mexican state government• Firms apply for grants for consultants/mentors

from consulting firms in Puebla• Limited supply of grants for eligible firms– Thus randomization good for two reasons:

• 1) Helped solve political problem, by choosing randomly no complaints of favoritism when allocating a scarce resource

• 2) Provides powerful impact evaluation by independent researchers to help strengthen future policy discussions

• Fairly small sample, 433 firms

Results

• After one year• Monthly firm sales & profits up 78% and 110%

respectively• Productivity increased– Productivity defined as profits unexplained by

assets

Demand Elasticities

• Large-scale experiment in Mexico, Compartamos Bank

• Randomized over branches spread throughout entire country

• Incorporates general equilibrium effects

Price

• Huge variance in rates around the world• Huge variance in depth of outreach• Significant debate, especially in high rate countries• Two sides to the calculation– Costs– Demand

• Most of the data/analysis/discussion is on costs• For years, World Bank (CGAP) and others pushed to

raise rates, to get to sustainability

Compartamos experiment

• Randomization at branch level• Data collected over 19 months• Two “take-up” sets of data– Specific face-to-face marketing– Natural over time process, i.e., branch level

outcomes with normal marketing, growth, gossip and general equilibrium effects

Experimental Design

• “Crédito Mujer” village banking loan product only for women

• Bank branches grouped into 80 geographic clusters across Mexico– Half assigned “high” rate– Half assigned “low” rate

• Difference of 10% (0.50% per month)

Branch Locations

Final sample included 132 branch offices in 80 geographic clusters across Mexico

“high” rate“low” rate

Results: More Clients

Results: Larger Loan Portfolio

All together for Compartamos

• Compartamos is a for-profit• Impact on society important• Promise to investors of course is that helping

society can be profitable.

• Revenues increased by about 11%• Costs did too• Net impact on profits: up about 3%– Statistically same as before

Measuring Social Impact with Credit Scoring

• Credit scoring– Difficult for SME sector– Even more difficult for nicroentrepeneurs– Much to be learned about optimal system• How to balance hard and soft information• How to build incentives for long term client loyalty• How to maintain safe banking principles

Experiments to measure impact

• Impact studies of microcredit have been done – and done and done and done…– Questions linger regarding identification

• Basic selection problems:– Who chooses to borrow? • Entrepreneurial spirit? Resourceful individuals?

– Who do MFI’s agree to lend to?– Program placement: MFI’s target growing areas

Microcredit Randomized Trials

• Now we are beginning to see a wave of them– South Africa: urban/peri-urban, for-profit, individual lending, formal sector

employed individuals (Karlan and Zinman, 2008)– Philippines: urban Manila, for-profit, individual lending (Karlan and Zinman,

2009)– India: Spandana, urban Hyderabad, for-profit, group lending (Banerjee, Duflo,

Glennerster and Kinnan, 2009)– Peru: Arariwa, rural, village banking, non-profit (Karlan and Zinman, 2010?)– Mexico: Compartamos, peri-urban/urban, village banking, for-profit

(Angelucci, Conley, Karlan and Zinman, 2011?)– Morocco: Al-Amana, rural, village banking, non-profit (Crepon, Duflo and

Pariente, 2010?)– Philippines: FICO and First Valley (getting under way, 2012?)– Bosnia: for-profit, individual liability, urban and rural (Augsburg, de Haas,

Hamgart and Meghir, 2011?)– Mongolia: group liability, rural, Attanasio et al

Simple but critical test

• One theory: markets are actually complete. • High prices for informal credit – Incomplete credit markets?– Or higher price for better service?

• Will increased loans higher debt or change in debt composition?

• If so, prima facie evidence for credit constraints

Basic Methodology

1. Lender randomizes marginal loan applicants:

100-point credit scorecard based on applicant’s:

1 – 30

Auto reject

60 – 100

Auto approve

31 – 45

Randomly

approve 60%

46 – 59

Randomly

approve 85%

• Business capacity

• Personal financial resources

• Outside financial resources

• Personal and business stability

• Demographic characteristics

Basic Methodology

2. Follow-up with household survey that measures:

• Borrowing, broadly defined

• Business income, expenses, and profits

• Investments, broadly defined

• Psychological and political outlook

Surveyors completed 1,114 of 1,601 in sample for70% response rate.

Number of days between treatment and follow-up:

Mean Median Standard Dev.

411 378 76

Why did the bank do this?

Weekly credit committees: slow, costly, subject to inconsistencies of subjective scoring.

Computerized credit scoring fast (loan decision in 1 hour!) and quantitatively-based.

Future scorecard revision requires data points on “below the line” applicants.

Market Settings

Small-business Microloan market in Philippines:

• For-profit rural bank

• Regulated but no viable credit bureau

• Unsecured

• Individual liability

• High-risk

• Short-term (13 weeks), fixed repayments

• Expensive by many international standards (63% APR)

Results

• Loan use increases: 9.6% more likely to have a loan– Evidence of market failure being solved

Impacts

• Key results:– Profits go up for men, but not women (consistent with

de Mel et al capital drop experiment in Sri Lanka)– Cut back in firm investments and cutback in formal

insurance– Increased education for families of male borrowers– Increased access to informal credit– Increased trust in community– Increased stress (consistent finding in South Africa)

South Africa

• Similar study• Consumer lending• Found increase in employment after getting a

loan• Net impact: 8 percentage point reduction in

poverty headcount ratio

Further research

• What are patterns of impact?• When should credit be increased?• Who should lenders (and their funders) target?

• Replication needed to further answer these questions. No one study can satisfy the policy questions being posed.– Need varying competitive settings– Need varying cultural and economic conditions.

Five ideas

• SME– Give a choice to a microentrepreneur

• JobOr

• Microenterprise

– What will she choose?– What are constraints? Managerial capital? Finance? Both together?

• Credit scoring• Electronic/mobile banking linkages to savings accounts• Savings

– Behavioral Economics applications

• Integration of health into banking– CARES

Thank you!

dean.karlan@yale.edu

http://karlan.yale.eduhttp://www.poverty-action.org

http://www.stickK.com