What is the impact of granting targeted microcredit on default?

Responsible researcher: Viviane Pires Ribeiro

Article title: THE EFFECT OF ORIENTED PRODUCTIVE MICROCREDIT IN BRAZIL: INCENTIVE TO DEFAULT?

Authors of the article: Wandnéia da Penha Magdalon and Bruno Funchal

Location of intervention: Brazil

Sample size: 49 observations

Big Sector: Finance

Type of Intervention: Relationship between the amount of productive microcredit oriented in Brazil and strategic default 

Variable of main interest: Strategic default

Evaluation method: Experimental Evaluation (RCT)

Assessment Context

In 2004, with the aim of expanding microcredit in Brazil, the Brazilian government issued Provisional Measure 226, which established the National Oriented Productive Microcredit Program (PNMPO), converted into Ordinary Law 11,110/05. This program aims to make resources available for Oriented Productive Microcredit (MPO), with the institutional objective of encouraging the generation of work and income among popular, formal and informal microentrepreneurs, with annual gross income of up to R$ 120 thousand. Therefore, the vast majority of informal entrepreneurs may not have financial assets to offer as collateral. Therefore, in accordance with Article 2 of Law 11,110/05, the granting of the MPO is permitted without the requirement for real guarantees, being replaced by alternative guarantees, to be defined by the operating financial institutions.   

Intervention Details

Da Penha Magdalon and Funchal (2016) analyze the impact of the public policy of inserting credit in the market on the default of productive microcredit guided by Law 11.110/05, which established the PNMPO. Using aspects of asymmetric information, the authors seek to understand the potential incentives for default generated by the design of the MPO contract, since the lack of clear punishment in case of non-payment would tend to produce incentives for moral hazard.  

The data used in the research were collected on the websites of the Central Bank of Brazil and IPEADATA. The information is aggregated at national level and is in a time series, covering the period from January 2011 to April 2015, totaling a sample of 49 observations. From the Central Bank website, credit information with resources aimed at individuals – microcredit aimed at consumption and micro-entrepreneurs – was used to measure the MPO (independent variable). Data relating to the default variable (dependent variable), CDI and inflation index were also collected by the Central Bank and unemployment and income rates via the IPEADATA website. 

Methodology Details

The research sought to test whether the granting of targeted productive microcredit encourages default, using a multiple linear regression model. In the model, the independent variable for granting the MPO was used with a time lag t-1, because the occurrence of MPO default, according to the authors, is not instantaneous. That is, only one month after granting the loan will the first delay in payment occur.

The econometrically estimated multiple linear regression model – to test the hypothesis that default is positively related to the increase in the amount of MPO – was represented by the following variables: Default in granting the MPO; Monthly amount of MPO concessions; Unemployment rate; Real average income of employed people; Interbank Deposit Certificate (CDI) interest rate; and national Broad Consumer Price Index (IPCA).

The regression equation contains four control variables, three of which relate to economic indicators – unemployment rate, average real income and IPCA – and an interest rate indicator, the CDI.

Results

According to the results found by the authors, the default variable for consumer microcredit has a non-significant relationship with the granting of consumer microcredit. The F probability test of 0.0259 indicates a strong correlation between the model variables for a 10% significance test. Therefore, it appears that the default on consumer microcredit is not related to the increase in credit, that is, credit granted outside the scope of Law 11,110/05 has no impact on the increase in default on consumer microcredit.

The results indicate a positive correlation of 0.0067, statistically significant, between default and the granting of the microentrepreneurial MPO. It was estimated that, for each unit increase in the microentrepreneurial MPO concession, the default rate of this portfolio will increase by 0.0067%. Thus, for a growth of 100 million in the loan, the forecast is an increase of 0.67% in the level of default, representing a relative growth of 18.30% in the average default rate for the period from January 2011 to April 2015 .

The authors calculated an average increase in MPO of more than 250 million when the sample is divided into two parts. This increase in MPO volume would imply an average increase of 1.67% in default, which justifies an increase of almost 80%, compared to the average level of default (2.08%) at the beginning of the observed period.

Statistics show the relevance of the impact of Public Policy on MPO default, confirming the research hypothesis. This significance was not observed for default in granting microcredit intended for consumption. Default explained by macroeconomic factors, such as the unemployment rate and inflation, is not significant in the model. Therefore, there is evidence to confirm the research hypothesis that the MPO encourages default due to moral hazard, given the limited responsibility of the borrower to fulfill his part of the agreement, since there is no harsher penalty in the contractual arrangement.

Public Policy Lessons

Research carried out by Da Penha Magdalon and Funchal (2016) highlights a positive relationship between default and the volume of productive microcredit oriented, suggesting that this type of debt contract encourages moral hazard problems and illustrates the economic consequences of poorly designed contracts and laws . In this sense, the research confirms previous studies that highlight the importance of the role of credit agents in expanding microcredit activities throughout the country. Therefore, the relationship between the credit agent directly with the customer at the location of their activity and monitoring during the term of the contract is essential to resolve moral hazard problems. In turn, the social guarantee of solidarity groups reduces the risk of adverse selection in MPO contracts.

Da Penha Magdalon and Funchal (2016) state that based on the results, actions can be suggested that review the way in which the law that regulates the MPO is written, providing counterparts or guarantees that encourage debt payment, discouraging strategic default. Furthermore, the authors suggest, for example, a survey among the main institutions operating the PNMPO to verify whether, in practice, there is actually monitoring by the credit agent during the term of the contract, as well as technical guidance, as well as verification whether the loaned resource is actually being used in the business that is the subject of the microcredit; whether there are sufficient numbers of credit agents for this purpose; whether they are technically capable of guiding the business’s financial planning; and, finally, whether these agents are fulfilling their role, defined by Law 11,110/05, or whether they are omitting relevant information.

Reference

DA PENHA MAGDALON, Wandnéia; FUNCHAL, Bruno. The effect of oriented productive microcredit in Brazil: Incentive to default?. BASE-Unisinos Administration and Accounting Magazine , v. 13, no. 4, p. 294-308, 2016.