Understanding Customer Behavior of Multiple Borrowing through Prospect Theory: Case Study of Indian Microfinance Clients

This paper uses prospect theory to analyze client behavior regarding multiple borrowing.

The paper states that multiple borrowing has become a major cause of concern for the microfinance industry. Literature review indicates that growing competition in the microfinance market reduces borrowers’ incentives for repayment. Absence of effective credit bureaus encourages borrowers to take multiple loans. The paper identifies two possible explanations for multiple borrowing:

• Negative shocks may affect the borrower’s business after they have taken and invested a loan, forcing them to take a second loan to repay the first;
• Microloans may be too small to cover the borrower’s need for a specific investment.

The paper uses behavioral finance to analyze borrowers’ decision-making in response to negative shocks. Prospect theory addresses how choices are framed and evaluated under conditions of risk. The study uses principles of the theory to frame six different scenarios, which are presented to microfinance clients during personal interviews. The paper presents data analysis of the responses. Results confirm behavioral irrationality of clients, and illustrate why they indulge in multiple borrowing.