Strategic default, multiple installments, and the role of informal moneylender in microcredit contract

Abstract

I model the role of strategic defaults and informal moneylenders on multiple-installment loan contracts offered by microfinance institutions (MFIs). The results show that a single-installment loan is not viable due to MFIs' vulnerability to strategic defaults and borrowers' lack of collateral. In contrast, a multiple-installment contract requires borrowers to borrow from the moneylender, who is immune to strategic default, in order to repay the MFI's early installments that are due before the project yields a return. Consequently, both default costs and borrowing costs increase and incentives to commit strategic default decline, making the multiple-installment contract profitable for MFIs.