One of the most important business innovations of the last fifty years is the group-lending model of microfinance. In place of familiar models of individual lending, the group-lending model leverages social connections and peer accountability among low-income borrowers to encourage timely loan repayment. While social influence is a powerful, positive force for financial markets under most circumstances, under crisis conditions, it can have unanticipated, adverse consequences.
In our new article published in the Strategic Management Journal, we investigate this possibility by studying the loan repayment behavior of approximately two million low-income borrowers following India’s 2016 demonetization policy. In November 2016, India’s demonetization policy invalidated 86% of cash overnight, catalyzing a severe liquidity crisis for those reliant on the cash-based economy. Loan default rates of microfinance borrowers jumped from 2% pre-demonetization to over 40% post-demonetization. However, these defaults were not evenly distributed. The increased defaults post-demonetization were disproportionately clustered within some centers. In probing why this might be the case, we investigated fine-grained data from a leading microfinance organization in India. We also gained vital insights from interviewing multiple borrowers and loan officers (also known as community service officers) across several villages. The investigation revealed that not only economic but also social relationships influenced borrowers’ default decisions.
Findings from this study demonstrate a fundamental risk many community-based business models face: the social mechanisms that drive success in regular times can also accelerate failure in periods of crisis. Whether triggered by economic crises or natural disasters, the dynamics that provide efficiency during stability can cause severe losses when things go awry. Mitigating such downsides entails several imperatives. First, integrating targeted risk management and scenario planning is crucial when reliance on community ties is high. Second, context specificity matters tremendously—community dynamics differ across demographics and regions. Third, cultivating positive relations with community leaders could provide resilience during adversity. Finally, the goal should not be to get carried away by the promise of the community-driven business model as a panacea to solve the complex challenge of financial inclusion but also carefully manage the potential downsides of harnessing social capital.
The intricate path toward serving low-income customers in emerging markets requires a keen awareness of the rewards and risks that community-driven business models entail. With a better understanding of such subtleties, businesses have the potential to sustainably deliver essential products and services to a vast segment of underserved customers in developing countries globally.
The journey towards any business model innovation demands not only creative thinking but also acute sensitivity to social dynamics at play that vary across contexts. As businesses navigate this intricate path, the insights from community-driven models can provide valuable lessons in guiding their contribution to financial inclusion.
