Transcript Randomized Controlled Trials in Rural Finance: An Example
Randomized Controlled Trials in Rural Finance: An Example from India
Michael Faye and Sendhil Mullainathan Harvard University March 2007 [email protected]
Agenda
Randomized Controlled Trials in Finance
Example from India: Jewelry Loans Experiment
Background on Jewelry Loans
Research questions & Results
Summary
RCTS ARE APPLICABLE TO MANY FINANCE QUESTIONS
Bank
Can loan to value ratios be increased without inducing additional default? What is the interest rate that maximizes profits?
Int’l Org.
What is the social impact of a given finance program?
Which intervention is more effective?
MFI
Can microfinance programs be made less rigid without inducing more default?
Is group lending necessary to ensure low default rates?
WHAT IS A RANDOMIZED CONTROLED TRIAL (RCT)?
Different interventions randomly tested in different places/people. Example: interest rate randomized Individuals randomly assigned to treatment and control groups Treatment group receives intervention Control group is not allowed to receive treatment (during evaluation period) Allows us to interpret results as causal What would have happened if individual did not receive treatment
WHY USE RCTs?
Not subject to psychological biases: We are all bad statisticians RCT eliminates this bias More precise and not subject to selection bias: RCTs can give precise numerical estimates of program effect Avoids conflict: Well-designed RCTs provide precise answers that avoid impasses Relatively cheap: While RCTs can be labor intensive and costly, it is more expensive to make a large-scale mistake WHEN RCTs ARE APPLIED TO THE RIGHT PROBLEMS, THEY PROVIDE A POWERFUL AND PRECISE METHOD TO GET ACCURATE ANSWERS FOR MANY BUSINESS AND POLICY DECISIONS
Agenda
Randomized Controlled Trials in Finance
Example from India: Jewelry Loans Experiment
Background on Jewelry Loans
Research questions & Results
Summary
BACKGROUND ON JEWELRY LOANS
What?
Jewelry loans are loans that are collateralized by gold jewelry.
Who?
Bank grants loans to • Individual consumers Area studied?
Tamil Nadu, India
HOW ARE JEWELRY LOANS DISBURSED?
Customer shows jewelry to appraiser in bank Appraiser weighs jewelry and subtracts non gold weight Customer chooses loan amount and interest rate
Rate of Interest
8.50% 9.50% 11.0% 13.0% 15.0%
LTV
70% 75% 80% 85% 90%
Term
18 months 12 months 180 days 90 days 45 days Bank teller disburses loan to customer
WHY ARE JEWELRY LOANS INTERESTING?
Question Observation
• Individuals did not want to borrow at a higher LTV at the same interest rate • Individuals are borrowing for predictable expenses (e.g., school fees) consistently • Pawnbrokers play a large part in the market • Why wouldn’t customers want to borrow more if they are credit constrained?
• Why not save for these expenses?
• Default is very low (<1%) • Why don’t customers borrow directly from bank?
• Can the lack of default be attributed to a sentimental value of the jewelry?
Agenda
Randomized Controlled Trials in Finance
Example from India: Jewelry Loans Experiment
Background on Jewelry Loans
Research questions & Results
Summary
OUR INITIAL RESEARCH QUESTIONS
Credit Constraints • Do people want to borrow more?
• Is bank being too cautious on its term structure Individual Consumption • What do individuals spend additional credit on (e.g., consumption, investment)?
Mental Accounting • Why aren’t individuals refinancing outside loans? Is mental accounting an important part of the story?
EXPERIMENTAL DESIGN IS ON 3 DIMENSIONS
LOAN TO VALUE • Increase LTV by 50 Rs/g TIMING • Offer higher LTV at time of initial transaction • Increase LTV by 100 Rs/g • Offer higher LTV at time of initial transaction but allow customer to come back for loan within a week • Send letter to random individuals with offer of higher LTV PRESENTATION • Suggest other uses of loan including loan consolidation • Ask if they need additional money for stated purpose of borrowing
Results
Individuals do not appear to be credit constrained: 40% of those offered an additional amount do not take more than they would have been eligible for without increase Statistically insignificant difference in loan taken of those offered extra and those not Individuals who are offered extra borrow at lower interest rates Mental accounting plays a role in refinancing decisions Small sample size still prevents accurate inference, but initial results suggest when prompted on outside uses of loan, individuals borrow more Default rates have not increased Despite the increase in credit limits, there does not seem to be any affect on default Social effects Survey still ongoing Anecdotal evidence suggests that many people are using loans to smooth consumption
Agenda
Randomized Controlled Trials in Finance
Example from India: Jewelry Loans Experiment
Background on Jewelry Loans
Research questions & Results
Summary
Summary
Significant increases in credit limits might be possible without increasing risk Psychological biases may prevent individuals from optimal refinancing: minor interventions might help overcome these biases Credit constraints might not be as severe as commonly assumed in some rural areas - before assuming demand for credit, we should understand the specific area RCTs can be a powerful tool for both business and policy decisions: they transformed medicine in the 20th century - perhaps they can transform development programs in the 21 st Organizations can help you test. If you are having trouble finding one, please contact me or Sendhil and we can direct you to one. ([email protected])