Moral Hazard Repayment Elasticity

In Simple Words

If a bank doubles the interest rate on a loan, borrowers feel the bank is taking too big a piece of their hard work, so they become less motivated to work hard to pay it back, causing default rates to skyrocket.

Research question

When microfinance institutions attempt to raise interest rates to compensate for higher default risk on flexible loans, borrowers may deliberately reduce repayment effort, undermining lender viability.

Participants

Model calibration based on 845 field experiment clients and survey willingness-to-pay data from 769 study participants in Kolkata, India.

Study Design

Empirical parameter calibration measuring the elasticity of the loan repayment rate with respect to a one-percentage-point increase in interest rates.

Results

When moral hazard elasticity exceeds 0.46 (percentage fall in repayment per 1 percentage point rise in interest rate), no zero-profit separating equilibrium exists for grace period credit contracts.

Takeaway

Measure borrower moral hazard elasticity prior to adjusting interest rates on flexible credit products to avoid triggering unsustainable default spirals.

Read alongside the research

Plain-English glossary

Original explanations, informed by the references below. Examples are illustrations, not data from the studies above. The research text stays unchanged.

Percentage points

The difference between two percentages.

ExampleA rise from 40% to 50% is 10 percentage points. Relative to the starting value, that is a 25% increase.

Office for National Statistics · Percentages ↗Read more about percentage points →

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