Insights from Behavioral Economics to Small Business Banking

Transcription

1 Insights from Behavioral Economics to Small Business Banking Antoinette Schoar Michael Koerner '49 Professor of Entrepreneurial Finance MIT Sloan School of Management CEPR-EBRD: Understanding Bank in Emerging Markets September 5-6, 2013

2 What is Behavioral Economics?

3 What is Behavioral Economics?

4 The Marshmallow Experiment

5 The Marshmallow Experiment

6 Giving in

7 Traditional Mapping Intention to Action Decision Actions Outcome Yes A B Yes No C D No

8 Behavioral Obstacles to the Translation Decision Actions Outcome People misjudge how the will behave Ex post need to justify actions (or just confused) Yes A Yes No B No

9 Why is this Relevant for Finance? Small changes in how financial products are set up significantly affect customer outcomes Credit risk is not a fixed type but endogenous to the state of the credit market The sophistication of financial institutions causally affects the structure of credit risk in the economy Banks have embraced retail financial tools for SME banking to reduce transaction costs But opportunities to use psychological insights to improve repayment behavior

10 Getting to the top of mind: testing the effectiveness of reminders Source: Karlan, McConnell, Mullainathan, and Zinman (2010) and Cadenas and Schoar (2011). Banks in Bolivia, Peru, the Philippine and Uganda Customers with loans of savings accounts Monthly text message reminders Estimate size of effect Generic text message reminder or highlight a particular goal

11 Text message have similar effects as 20% reduction in interest rate 18% % reduction in late payment 16% 14% 12% 10% 8% 6% 4% 2% 0% * Heterogeneity who responds to each treatment: the young are more like to respond to SMS No reminder Generic reminder Goal-specific Cash incentives SMS Reminder reminder for on time payments

12 Text message reminders increase savings Percentage increase in savings 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% No reminder Generic reminder Goal-specific reminder

13 Information Avoidance: Foreclosure Resolution Distress homeowners do not return calls and mailing about mortgage reduction offers >85% of borrowers in distress do not call back Lack of information seeking to avoid dealing with pain Type of outreach matters Highly distressed borrowers respond only to soft touch, constructive messaging Casually distressed borrowers respond to harsh messages (strategic default) 1 3 Mullainathan, Schoar and Shafir (2011)

14 Take Away People suffer from inattentiveness even toward goals that are important to them Not following through on goals results in sub-optimal outcomes Reminders can help people stick to a plan Text message reminders are very cost-effective Content and type of message matters

15 Loyalty as Alternative Collateral Idea: Many SMEs do not have collateral to get a bank loan even if they have cash flow to pay it. Test a collateral free loan product and use relationships as alternative collateral?

16 Different Hypotheses for Effectiveness of Outreach Challenge: Test if relation building can ensure repayment and increase client loyalty Can the services that bank provides substitute for the lack of financial infrastructure in the market? Depends on the reasons behind defaults Strategic default: Reduction of moral hazard? Loyalty: Build personal relationship between loan officer and clients? Behavioral factors: SMEs have poor planning skills

17 Set Up Only uncollateralized lending facility to SMEs in India Credit assessment is based on a score card model Centralized risk team makes credit decisions based on observable information, e.g. tax filing, bank statements Loans are structured as a one year overdraft facilities Payment modality like a credit card: monthly interest payments and 5% of balance has to be paid Loan size between $10k-$50K Penalty interest rate starts after 30 days late

18 Implementation Hire six relationship managers to follow up with clients in treatment groups A and B Very clear separation from credit assessment team Convey to borrowers that relationship managers will not be involved in loan renewal Relationship managers have set scripts to call clients Check in every two weeks independent of loan status. Solve problems with accounts, remind customers of delays in payment if necessary etc No cross selling (!)

19 Experiment Set-up Group A: No monitoring treatment Control Group Group B: Reminder treatment Send SMS with interest and principal due every month. Follow up with phone call if clients have outstanding balances Group C: Medium touch treatment Random loan officers follow up with clients regularly to solve problems, understand the nature of the business Group D: Personal touch treatment Assign individual loan officer to create ongoing relationship with client. Treatment as in Group C.

20 Default Rates Differ Drastically by Treatment Delinquent Customers per Treatment Group 20% 19% 18% 16 % 15 % 14% 14 % 12 % 12% 11 % 10% 10 % 9% 10 % 9% 8 % 8% 6% 6 % 6 % 4 % 3% 2 % 0% 0 % SBL, Loans 5+ Lakh, CPA Cities [N=774] SBL Power, Loans 5 + Lakh, CPA Cities [N= 311 ] SBL, Loans 5 + Lakh, Non - CPA Cities [N= 158 ] SBL Power, Loans < 5 Lakh, Non - CPA Cities [N= 505 ] High - Touch (Relationship) Medium - Touch (Monitoring) Low - Touch (Reminders) Control -

21 Differences in Account Behavior

22 Results I Significant reduction in late payments for borrowers in groups A and B Almost 20% reduction in late payments Onset of late payment and number of late payment spells are reduced for treatment groups A and B Ultimate default seems to converge: Accounts in default are handled by separate department Improved outcomes at renewal stage for borrowers in groups A and B

23 Reachability

24 Complaint Behavior

25 Results II Compare treatment groups A versus B Other treatment groups did not have outreach data Significant higher likelihood of reaching clients in A group than B; especially on second follow up call Likelihood of complaints are lower for treatment group A but conditional on complaint the nature of the complaint seems more serious Find similar results for ability to reach customers for follow up calls by ICICI bank and cross selling

26 Take Away Personalized attention by loan officers matters for repayment behavior and loan renewal decisions Groups A & B have significant change in repayment Relationship lending affects client s willingness to engage in moral hazard behavior and loyalty to the bank Relationships constitute alternative collateral

27 Conclusion Rethink model of credit risk in loan markets Default decisions are situation contingent Screening versus moral hazard? Stability of prediction models? Advances in lending products helps borrowers improve their credit type Virtuous cycle of credit access Need more work on equilibrium effects and competitive responses of banks

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29 What is Behavioral Economics? Clocky helps you get out of bed. Hit the snooze button and it rolls off the nightstand, around the room and hides. Next time it goes off you must get up just to find it.