laboratory experiments to evaluate policies: an example from islamic microfinance

Laboratory Experiments to Evaluate Policies:

An Example from Islamic Microfinance

Mohamed El-KomiUniversity of Texas at Dallas

Cairo conference: Perspectives on Impact Evaluation31st March – 2nd April, 2009

Islamic Microfinance

Microfinance Can Alleviate Poverty

Small loans to disadvantaged individuals (or groups).

State of Microfinance: High rates of interest (some reached APR 100%). Receive Subsidies (95% of microfinance institutions,

UNCDF 2005). Primarely rural environments (e.g. Grameen bank and

BRAC in Bangladesh, TriBanco in Brazil, Prodem in Bolivia and FINCA International).

Challenges:Monitoring: Focus on group lending (less appropriate for

urban settings).Lack of tracking individuals + Increasing number of

MFIs.

Islamic Microfinance

Islamic Finance Islamic commercial banking:

Assets exceed $700 billion ($160 billion in 1997). Market growing 10-15% per year (The Economist 4

September 2008). Relatively protected from current economic crisis

(Financial Times Advisor 10 November 2008).

Main principles: Ban on interest + Equitable risk sharing.

Mechanisms: Cost-plus sales (the most widely used). Profit-sharing. Joint venture financing.

Islamic Microfinance

Islamic Microfinance?• Can expand potential clientele. • Increase take-up rates.• Enrich contractual settings.• New field (HSBC currently establishing an Islamic

microfinance project in Pakistan).

• Our project: Experimental investigation of Islamic microfinance

products. Possible field implementation and evaluation.

Islamic Microfinance

Controlled ExperimentsControlled environment to mimic the decisions

of interest (avoid confounds).

Wind-tunnel (Plott 1979).

Induced valuation: paying experimental participants based on their decisions (Smith 1976).

Random assignment (unlike observational data or traditional interventions).

Inexpensive pre-tests.

Islamic Microfinance

Previous Work Group vs. individual lending:

Same repayment rates (Philippines) (Gine and Karlan 2008) (Karlan and Harigaya 2006).

Risk taking (Gine et al. 2006). Group size irrelevant - information central (Carpenter 2002).

Interest rates: Same repayments for consumer microcredit (South Africa)

(Karlan and Zinman 2008). Lower repayment for individuals, higher repayment for groups

(Abbink et al. 2006).

Tracking borrowers: Reduces moral hazard (microfinance) (Gine et al. 2006),

(microcredit) (Karlan and Zinman 2008).

Islamic-compliant contracts – not previously examined experimentally.

Islamic Microfinance

Our SettingEntrepreneurial individual lending.

Focus: moral hazard (vs. adverse selection) (see, e.g., Cason et al. 2008, Cull et al. 2008, De Aghion and Morduch 2005, Gine et al. 2006, and Stiglitz 1990).

Compare ex post moral hazard in interest-based vs. Islamic contracts.

Used to design field experimentation.

Islamic Microfinance

Our ExperimentsGet loan, invest in risky project, learn outcome

(lender does not), pay back or not (moral hazard).

Interest-based (10%) – no risk sharing.

Profit-sharing (80%) – complete risk sharing.

Joint Venture (40%, 60%) – partial risk sharing.

Hypothesis: More default risk sharing does not significantly decrease repayment rates.

Islamic Microfinance

Interest-based

Islamic Microfinance

Profit-Sharing

Islamic Microfinance

Joint-Venture

Islamic Microfinance

Summary of Future WorkEvaluate effectiveness of contractual types in

the lab:Different participants: Students, Muslim students,

disadvantaged Muslims, microfinance clientele.

Design field implementation (Bangladesh).

Choice of contract and its impact on sustainability.

Evaluate full implementation.

Islamic Microfinance

THANK YOUm.elkomi@utdallas.edu