Social Collateral, Repayment Rates, and the Creation of Capital ...

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ScienceDirect Procedia Economics and Finance 31 (2015) 823 – 828

INTERNATIONAL ACCOUNTING AND BUSINESS CONFERENCE 2015, IABC 2015

Social collateral, repayment rates, and the creation of capital among the clients of microfinance Nabawiyah Abdul Hadia, Amrizah Kamaluddinb* Accounting Research Institute(ARI), University Teknologi mara, 40450 Shah Alam, Selangor Darul Ehsan

Abstract The present paper seeks to examine the social collateral model for Malaysia Microfinance Institutions (MFI). This study proposes the social collateral model consists of social capital (trust and network), group pressure and training is used as supporting mechanism to encourage loan repayments and support the borrowers in creating human capital and economic capital. The social collateral model offers guidelines to the MFI in distributing the microfinance loan to the borrowers effectively and assesses the ability of the borrowers in the loan repayments. This would ensure survival of the borrowers in the microfinance program and lead to enhancement of their social and economic growth or lives. A vital social collateral model would contribute to the MFI in term of financial and managerial sustainability of MFI in the microfinance industry. ©©2015 by Elsevier B.V.byThis is an open 2015Published The Authors. Published Elsevier B.V. access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/). Peer-review under responsibility of Universiti Teknologi MARA Johor. Peer-review under responsibility of Universiti Teknologi MARA Johor Keywords: Social collateral; microfinance institutions; repayment rates; human capital; economic capital;

1. Introduction The failure of the formal financial institutions to provide financial services to the poor people is the major reason for the emergence of informal financial institutions. Consequently, the emergence of microfinance revolution enables the poor people to increase households’ income, stimulates economic activities and acts as an effective tool to alleviate poverty (Bennett & Cueves, 1996; Ledgerwood, 1999). A study done by Maes and Reed (2012) reported that there were 3652 microfinance institutions (MFI) serving more than 200 million borrowers. In that regard,

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2212-5671 © 2015 Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

Peer-review under responsibility of Universiti Teknologi MARA Johor doi:10.1016/S2212-5671(15)01172-7

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General Assembly of United Nations declared that year 2005 was the Year of Microcredit while Mohammad Yunus and Grameen Bank were awarded with Nobel Peace Prize in 2006 ( Mahjabeen, 2008). The term of microfinance generally recognized as “poor people access to basic financial services such as loans, savings, money transfer services and microinsurance” (Consultaive Group to Assist the Poor, 2009). Nowadays, microfinance is considered as a tool to reduce or to eradicate poverty (Yunus, 2003), to develop self-employment opportunity (Karnani, 2007), and to “bring prosperity to the aspiring poor” (Prahalad, 2006, p.2). Ashta and Fall (2012) stated that microfinance provides opportunity to poor people who have the entrepreneurship abilities and skills to access the capital. Therefore, by providing them with financial services, they would be able to start a business. Furthermore, they are not the delinquent borrowers since microfinance is the platform for the poor to get more loans in future (Yunus, 2003). Previous researches indicated that the repayment rates among the poor people are higher between 97% and 98% (Yunus, 2003; Mahjabeen, 2008; Griffin, 2009).

1.1. Social collateral and repayment rates Generally, the term of social collateral is synonym with the microfinance loan contracts. Since its inception, microfinance has primarily operated on social collateral and has created access for the poor to financial services. According to Rotzer (2007), the incentive of social collateral was adopted in order to encourage the micro recipients to repay the loans. This is supported by Conning (1996) who is opined that social collateral created through group lending approach provides some assurance that the micro recipients will not delinquent in repayments. Thus, there are four constructs that should be embedded in the social collateral model such as trust, network, group pressure and training. Social collateral generally considered social capital as essential elements upon the successful of microfinance program. Trust, network and less on norms are the resources which can adopted in group lending approach (Akram & Routray, 2013). In a perspective of a borrower, trust makes loans possible for them while for lender perspective, it provides guarantee not to default in repayment (Olomola, 2000). Previous researchers have found that trust between the group members influence the repayment performance of the micro recipients (Cassar, Crowley & Wydick, 2007; Khandker, 2012; Postelnicu, 2012). These studies suggested that trust would encourage the cooperation among the group members, the understanding of each other businesses, and to ensure that burdening the other group members was not an option, should the repayment failed. By preserving a close networking with the relatives and friends and involved in business courses, it enables the group members to extract the information about the market opportunities and thus reduce the cost of screening and monitoring (Okten & Osili, 2004). Similarly, Woolcock and Narayan (2002) and Putnam (1993, p.169) emphasized that networking is heavily embedded in microfinance program as it “can improve the efficiency of society by facilitating coordinated actions”. Networking is a vital tool for micro recipients to have greater access to information, new clients and business network (EUROPS, 1997). Furthermore, Karlan and Valdivia (2007) found significant association between network and repayment loan. This implies that the strong networking leads to better access of financing, as a medium to business opportunity, and ensure repayment are on schedule. Training is necessary for the enhancement of personal skills especially for those who are at the stage of starting the business (Cunha, 2007; Robinson & Malach, 2004; Ying, 2008). Providing microcredit with training may instill the mindsets and confidence of the women’s abilities, skills and attitudes to start up with a new business (Tundui & Hawa, 2013). Women borrowers are left behind men due to the facts of low educational levels, higher unemployment rates and being discriminates by the upper level society. Therefore, microfinancing offers training to the women borrowers in order for them to acquire necessary skills to start with the small business, to generate income and to be able to repay the loans. A study by Al-Azzam, Hill and Sarangi (2012) has found a significant association between group pressure and repayment rates. It implies that the group leader may exert peer pressure in order to encourage group members to make repayments on time. This finding is consistent with the outcomes reported by Banerjeeet al. (1994). The results from these studies concluded that the monitoring and pressure employed by the group leader act as an assurance to cover the repayments. CARE International UK opined that group pressure and peer monitoring as the


important roles to repay the loans. They further clarified that peer pressure as a guarantee for the loan recoveries. If one of the group members defaults, thus, it would affect the group members to apply for the next loan. The current study infers that the four constructs of social collateral model is used as supporting mechanism to encourage loan repayments, to maintain sustainability of micro finance institutions and to improve the income of the micro recipients. 1.2. Social collateral and creation of capital Griffin (2009) highlighted that the group lending approach that develops social collateral will be able to create more human capital and economic capital due to the effective teamwork and collaboration, supports each other and more affected by group pressure. Furthermore, it is consistent with Griffin (2012) that women borrowers are capable to develop more social capital because women are able to build strong network connection between the individuals in the group to secure the informing borrowing. Morris, Woodworth and Hiatt (2006) in a study performance of small entrepreneurs in Bulgaria and Philippines which are regard to individual lending approach and group lending approach reported that the group lending approach has shown better performance and continuously increasing concern among each other. It is due to the fact that the organizations have built social capital. Social capital can be created through trust, social ties and network. Armendariz and Morduch (2000) stressed out that the group lending approach will provide training to borrowers on financial literacy, business skills and management capabilities. Drawing from Griffin (2012), this study assumed that the female borrowers that engage in group lending approach are more motivated to increase the human capital by putting more effort to learn and to gain more knowledge in business management. In spite of that, Mokhtar (2011) found that individual in the group members will exert the pressure to ensure that each of the group member meets the loan repayment schedule and to improve income household. 1.3. Trust and creation of capital According to Akram and Routray (2013), trust and cooperation among the group members will enhance the opportunity of lending the money and affordability to repay the loan. Trust among the group members may influence repayment rates and business growth. If the group members have trust and strong relationship among each other, there is a lower possibility of default in repayment (Armendariz de Aghion & Morduch, 2005). Similarly, Karlan (2007) who studied the Trust Game experiment also emphasized that trust is a vital element to help in determining the success of group lending approach. If the micro-recipients failed to survive and default in repayment, the borrowers will encourage and provide an opportunity to enter into the business market and compete with other small entrepreneurs. 1.4. Network and creation of capital Basically, network is the element of social capital. Putnam (1993, pp.173) defined “social capital as network, trust and norms, that can improve society efficiency by facilitating coordinated action”. Karlan (2007) found that higher network leads to lower default and lower default implies a higher on return on savings. This relationship suggested that members with strong network may refer to those who are much closed to each other and shared same culture and belief are more likely to have more savings by generating higher repayment rates. The findings also suggested that good social network among the group member would lead them to lend out all of their savings to the other group members as one month internal loans. This is supported by Woolock and Narayan (2000) which opine that “social capital as community level organization network is good for economic development” especially for the poor people. Griffin (2012) has emphasized that social network is the good indicator to create more economic capital by generates more repayment rates.

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1.5. Group pressure and creation of capital Group pressure seems to be a vital factor in contributing to the success of borrowers in microfinance. Previous researchers have identified group pressure as the significant element to encourage micro-recipients to make repayment on time (Ahlin and Townsend, 2007; Cassar et al., 2007; Karlan, 2007) and in return good repayment rates have a positive relationship with financial capital (Griffin, 2012). This is because good repayment rates may help low income people to gain and to retain access to finance. Thus, it would lead to the enhancement of the economic development at the level entrepreneur. Griffin (2012) further illustrated that by putting the pressure on micro recipients it would encourage them to repay loans, “which in turn leads to increase survival in the MFI program, increased access to loans and economic capital”. 1.6. Training and creation of capital The major activity of microfinance is not only providing financial services to the borrowers but also to provide training in literacy and management capabilities. Armendariz and Morduch (2004) found that training may help the borrower with lower literacy to gain more knowledge and improve the business skills. Karlan and Valdiva (2010) stated that the goal of the training is to teach micro-recipients on entrepreneurial skills such as “how to treat clients, how to improve profits, where to sell and how to produce goods and services. By having such skills, it would lead to more sales, profits, and more staffs. Furthermore, it will also improve the business performance and the performance of the microfinance institutions. The microfinance institution may offer more financial capital to micro-recipients when they are less likely to default in repayment and also successful in managing their business. According to Dixen, Ritchie, and Siwale (2007), lower repayment rate would happen when the loan officers did not observe and monitor the borrowers and failed to provide training on financial aspect. This is consistent with Mokhtar, Nartea and Gan (2009) who highlighted that micro-recipients who are involved in business oriented activities are more capable to repay the loans and may enjoy the gained from the business profit. 1.7. Social collateral model and conclusion The objective of this study is to examine the social collateral model for Malaysia Microfinance Institutions (MFI This study proposes the social collateral model consists of social capital (trust and network), group pressure and training is used as supporting mechanism to encourage loan repayments and support the borrowers in creating human capital and economic capital. This is a conceptual paper, thus, no empirical finding is included. Therefore, the proposed social collateral model developed in this study is presented in Figure 1.


Features of social collateral Trust

Network Repayment rates

Creation of capital x Economic capital x Human capital

Group pressure

Training

Figure 1: The proposed social collateral model In sum, the social collateral model offers guidelines to the microfinance institutions (MFI) in distributing the microfinance loan to the borrowers effectively and assesses the ability of the borrowers in the loan repayments. This would ensure survival of the borrowers in the microfinance program and lead to enhancement of their social and economic growth or lives. A vital social collateral model would contribute to the MFI in term of financial and managerial sustainability of MFI in the microfinance industry. Acknowledgements We would like to thank Accounting Research Institute (ARI), Universiti Teknologi MARA Malaysia, in collaboration with the Ministry of Higher Education Malaysia (MOHE) in providing the financial support for this research project. We are indeed very grateful for the grant, without which we would not be able to carry out the research. References Ahlin, C., & Townsend, R. M. (2007), “Using repayment data to test across models of joint liability lending”, The Economic Journal, Vol. 117, pp. 11-51. Akram, S. & Routray, J. K. (2013), "Investigating causal relatiosnhip between social capital and microfinance", International Journal of Social Economics, Vol. 40, No. 9, pp. 760-776. Al-Azzam, M., Hill, S., Sarangi (2012), "Repayment performance in group lending: Evidence from Jordan", Journal of Development", Vol.97, pp. 404-14. Armendariz, B., & Morduch, J. (2004), "Microfinance beyond group lending", Economics of Transition, Vol. 8, pp. 401-420. Armendariz, B. , & Morduch, J. (2005), The Economics of Microfinance, MIT Press, Cambridge, MA. Bennet, L., & Cuevas, C.E. (1996), "Sustainability Banking with the poor", Journal of International Development, 8(N0.2), pp. 145-152. Cassar, A., Crowley, L., & Wydick, B. (2007), "The effect of social capital on group loan repayment: evidence from field experiments", The Economic Journal, Vol. 117 No. 517, pp. 85-106. CGAP, Consultative Group to Assist the Poor (2009), "Measuring access to financial services around the worls", Washington, The World Bank, pp. 1-92. Conning, J. (1996), “Group lending, moral hazard, and the creation of social collateral”, working paper 195, University of Maryland, College Park.

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