Liquidity defaults and progressive lending in microfinance: A lab‐in‐the field experiment in Bolivia

Many microfinance institutions (MFIs) use dynamic incentives in combination with progressive lending schemes to reduce defaults. However, the specific role of progressive lending has never been tested empirically, while observational evidence in other contexts points to potentially adverse effects. Using an experimental approach, we study the impact of progressive lending on overborrowing, attending to the possibility that progressive lending may actually increase liquidity defaults. We organize a framed field experiment in the municipality of Coroico, Bolivia, inviting 271 members of an MFI to participate in an experimental game. In Bolivia, the penetration rates of microfinance are among the highest in the world, progressive lending systems are a common practice, and the concept and practices of microfinance are well known among most people. We find that participants who borrowed over multiple rounds with progressively increasing borrowing caps showed increased liquidity defaults once the caps became unconstraining compared to those without progressive lending. We speculate that this result stems from anchoring borrowing loan requests on the credit limit set by the lender and formalize this rationale in a model for credit demand and naive borrowers. MFIs should consider the potential perverse anchoring effects of progressive lending when designing policies aimed at reducing overborrowing.