Psychology and Economics: What it Means for Microfinance
This note uses behavioural economics to examine the problems of microfinance clients.
Everyday economic decisions have richer psychological underpinnings than the standard economic model allows. People are restrained in their capacity to think through problems, and not every decision is methodically contemplated, calculated and executed. Psychological fallibilities that affect all groups may have particularly large effects on the poor because of their already precarious financial state. The poor find it difficult to:
- Plan, and this makes them susceptible to missing fixed repayments, borrowing instead of using saved funds and over-borrowing;
- Stick to a plan, making them susceptible to simultaneous borrowing and saving;
- Assess probability of risk;
- Analyze prices, due to which they may not always pick the best investment projects.
The behavioral economic framework helps to understand why debt discipline is a good mechanism for microfinance clients. It is also useful when thinking about common accusations leveled at the microfinance sector. Finally, behavioral economics demonstrates that institutional design in microfinance is not only about providing access to financial services, but also about solving issues that poor microfinance clients face on a daily basis.
