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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

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randomized controlled trials in rural finance an example from india

Randomized Controlled Trials in Rural Finance: An Example from India

Michael Faye and Sendhil Mullainathan

Harvard University

March 2007

[email protected]

agenda
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
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
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
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

agenda6
Agenda
  • Randomized Controlled Trials in Finance
  • Example from India: Jewelry Loans Experiment
    • Background on Jewelry Loans
    • Research questions & Results
  • Summary
background on jewelry loans
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

how are jewelry loans disbursed
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
why are jewelry loans interesting
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%)
agenda10
Agenda
  • Randomized Controlled Trials in Finance
  • Example from India: Jewelry Loans Experiment
    • Background on Jewelry Loans
    • Research questions & Results
  • Summary
our initial research questions
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?
slide12

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
results
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
agenda14
Agenda
  • Randomized Controlled Trials in Finance
  • Example from India: Jewelry Loans Experiment
    • Background on Jewelry Loans
    • Research questions & Results
  • Summary
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 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. ([email protected])
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