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Randomized Controlled Trials in Rural Finance: An Example from India. Michael Faye and Sendhil Mullainathan Harvard University March 2007 mfaye@fas.harvard.edu. Agenda. Randomized Controlled Trials in Finance Example from India: Jewelry Loans Experiment Background on Jewelry Loans

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Randomized Controlled Trials in Rural Finance: An Example from India

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Randomized controlled trials in rural finance an example from india l.jpg

Randomized Controlled Trials in Rural Finance: An Example from India

Michael Faye and Sendhil Mullainathan

Harvard University

March 2007

mfaye@fas.harvard.edu


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Agenda

  • Randomized Controlled Trials in Finance

  • Example from India: Jewelry Loans Experiment

    • Background on Jewelry Loans

    • Research questions & Results

  • Summary


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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?


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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


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    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


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    Agenda

    • Randomized Controlled Trials in Finance

    • Example from India: Jewelry Loans Experiment

      • Background on Jewelry Loans

      • Research questions & Results

    • Summary


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    BACKGROUND ON JEWELRY LOANS

    What?

    Who?

    Area studied?

    Jewelry loans are loans that are collateralized by gold jewelry.

    • Bank grants loans to

      • Individual consumers

    Tamil Nadu, India


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    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

    • Bank teller disburses loan to customer


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    WHY ARE JEWELRY LOANS INTERESTING?

    Question

    Observation

    • Individuals did not want to borrow at a higher LTV at the same interest rate

    • Why wouldn’t customers want to borrow more if they are credit constrained?

    • Why not save for these expenses?

    • Individuals are borrowing for predictable expenses (e.g., school fees) consistently

    • Why don’t customers borrow directly from

    • bank?

    • Pawnbrokers play a large part in the market

    • Can the lack of default be attributed to a

    • sentimental value of the jewelry?

    • Default is very low (<1%)


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    Agenda

    • Randomized Controlled Trials in Finance

    • Example from India: Jewelry Loans Experiment

      • Background on Jewelry Loans

      • Research questions & Results

    • Summary


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    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?


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    EXPERIMENTAL DESIGN IS ON 3 DIMENSIONS

    PRESENTATION

    LOAN TO VALUE

    TIMING

    • Increase LTV by 50 Rs/g

    • Offer higher LTV at time of initial transaction

    • Suggest other uses of loan including loan consolidation

    • 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

    • Ask if they need additional money for stated purpose of borrowing

    • Send letter to random individuals with offer of higher LTV


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    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


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    Agenda

    • Randomized Controlled Trials in Finance

    • Example from India: Jewelry Loans Experiment

      • Background on Jewelry Loans

      • Research questions & Results

    • Summary


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    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 21st

    • Organizations can help you test. If you are having trouble finding one, please contact me or Sendhil and we can direct you to one. (mfaye@fas.harvard.edu)


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