PLAN DE MANEJO AMBIENTAL

This chapter focuses on microfinance clients and how psychological biases, cognitive biases, sociological influence and socio-demographic and economic factors may influence their successful debt management. First, the reasons for over-indebtedness stemming from psychological and cognitive biases are discussed. The neo-classical model of economics includes the assumption that actors are rational utility maximizers who have perfect information at their hands when taking decisions (Akerlof 1991, 1; Goodwin et al. 2015, 178, 183). Behavioral economics challenges this axiom. To do so, behavioral economists depend heavily on scientific experiments to provide insights about reasons for individuals behaving a certain way in situations. The core claim is that a more complex model of motivation than the one suggested by neo-classical theory is required to explain human behavior. Instead of rational actors, behavioral economists assume the actors’ rationality to be bounded by cognitive biases, and the information accessible and the time available when making a decision (Goodwin et al. 2015, 184; Simon 1972, 163–164). Second, sociological influences that may impact debt management negatively are presented. Third, socio- demographic and economic factors influencing the debt management of microfinance clients are considered.

As I pointed out above, microfinance literature mainly addresses the external, institutional, and systemic perspective of the causes of over- indebtedness. Only a few microfinance scholars are concerned with the causes of over-indebtedness on the individual level (in the broadest sense Gonzalez 2008). Most of the studies referred to in this chapter have been carried out in industrialized countries (Barr, Mullainathan, and Shafir 2009; Sprenger and Meier 2012; Campbell 2006; Bertrand, Mullainathan, and Shafir 2004; Anderloni and Vandone 2008). Still I will try to transfer and adapt these insights to the microfinance context.

10.1.1.3.1

Psychological and Cognitive Biases

For the case of microfinance, behavioral economics tries to find explanations why a consumer would choose one product or service over another or why one client would default on a loan and the other would not. The microfinance and the U.S. mortgage crisis have shown again that the neo-classical model assuming rational agent behavior in competitive markets does not have to hold true after all. As discussed above individuals’ decisions are limited by their cognitive capabilities, by existing information, and the time available in order to make a decision (Goodwin et al. 2015, 184; Simon 1972, 163–164).

First, studies show that client behavior is rather governed by their cognitive capabilities, their own ideas and impulses than by „deliberative intent“ and „normative ideals“ (Barr, Mullainathan, and Shafir 2009, 27). Studies show that clients lack self-control, are over-confident, and, or have inconsistent time preferences (Barr, Mullainathan, and Shafir 2009, 32; Schicks 2010, 12). Microfinance clients might, for example, be tempted by immediate consumption and assess a loans’ benefits presently as more significant than its potential benefits in the future. But decisions a client makes grounded on her present utility function, are „unlikely to maximize long-term individual welfare” (Schicks 2010, 20). Behavioral economics has different explanations why individuals might act against their long-term well-being: the most prominent one being the ‘hyperbolic discount function’34. Hyperbolic discounting assumes consumers have inconsistent preferences, which lead them to take decisions that negatively impact their long-term well-being. For example, last year I committed that at the beginning of this year I would start an ambitious savings plan in order to be able to buy a house in the future. But as this year was starting, I decided that I would start saving next year because I was not yet ready to undergo the consumption sacrifices that I would have to make to meet the goals of the savings plan (Laibson 1997, 445–446). Inconsistent time preferences

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Two other well-known approaches of behavioral economics to explain time

inconsistencies are ‘procrastination’ (see Akerlof 1991) and ‘dual self’ (see Fudenberg and Levine 2006).

lead to the decision to postpone the savings plan yet for another year. Analogously, whether or whether not a client uses her loan for immediate consumption depends on the importance she ascribes to the immediate consumption in comparison to the potential long-term benefit of the loan. Hyperbolic discounting presumes that due to inconsistent preferences, consumers are motivated to „constrain their own future choices” (Laibson 1997, 443). Therefore, inconsistent time preferences may add to microfinance clients being prone to over-indebtedness.

Second, existing information greatly impacts the decision making of clients. An important source of decisions made by clients, which might lead to over-indebtedness, stems from asymmetric information. Only this time it is not the MFI lacking information about the client as with the problems of adverse selection and moral hazard but rather the client lacking information about the offerings of the MFI. Clients often lack information about microfinance products and their financial literacy in general is low (Schicks 2010, 12). Therefore, microfinance clients are likely to be susceptible to marketing and if financial products are presented in a misleading way, such as product prices being disclosed without additional fees, clients may buy products that exceed their financial limits.

Third, loans are sometimes needed on short notice and clients lack the

time to compare offers of different MFIs. A study by Meier and Sprenger (2012) that was carried out in the U.S. showed that having an urgent need for a loan predicts creditworthiness. Hence, individuals that will wait for their loan will have a higher probability of paying back their loan in contrast to the individuals having an immediacy bias (Sprenger and Meier 2012, 2). Since often microfinance clients do not have much time to decide about getting a loan they might end up buying a product that neither suits them nor is reasonably priced. Credit decisions made under these conditions make microfinance clients prone to over-indebtedness.

Finally, cognitive and psychological biases may also set limits to the

ability to be an entrepreneur, because not everybody is a born

entrepreneur. Although it is a fact that mainly poor people are depending on self-employment because of a lack of wage jobs, it is evident that not all of

them are ready to or are qualified to be an entrepreneur (Karnani 2007, 38). This may lead to money mismanagement and bad business decisions and may peak in over-indebtedness.

10.1.1.3.2

Sociological Influence Factors

The three main sociological factors influencing the debt management of clients are consumerism, economic socialization, and support of the family.

Consumerism, as the focus on material goods, is an issue in microfinance. The consumption of goods represents one’s standing and identity in a society. This phenomenon is not exclusively observed in the realm of microfinance. Nevertheless, it is evident that the social pressure of consumption may drive clients of microfinance to take up too much debt. Whether borrowers can manage their debt is also dependent on their

economic socialization. Economic socialization includes how acquainted clients are with money management, and debt management specifically. For example, if current borrowers can draw on experiences from their parents and how they managed their money and debt, it helps them to successfully manage their own debt or at least avoid the mistakes their parents might have made in the past (Stone and Maury 2006, 554). Inversely, a lack of economic socialization might add to the risk of over-indebtedness. Furthermore, feeling obliged to support family members at any cost is rooted in many cultures. The responsibility many borrowers feel towards their family and community - meaning that they feel obliged to support them financially – may lead to irresponsible borrowing (Schicks 2010, 13).

10.1.1.3.3

Socio-Demographic and Economic Factors

Also socio-demographic and economic factors might provide explanations why clients take up unmanageable debt. Some of the socio-demographic factors where over-indebtedness among microfinance clients is prominent are the following35: young age, many and small children, lack of education, illiteracy, and illness. The most prominent economic factors negatively impacting the debt management are low income, unemployment, money mismanagement and income fluctuations (Anderloni and Vandone 2008, 15; Collins et al. 2011, 478). Gonzales (2008, 100) shows that loans are often partly used for consumption instead of being completely used for economic activity. Therefore, returns on investments – meaning the returns on the given loans – cannot be as high as assumed by lenders. Borrowers might consequently not be able to repay on time and run into debt stress and eventually into over-indebtedness.

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For further socio-demographic factors that may lead to over-indebtedness, see Schicks (2010, 13–14).