Authors: Dyotona Dasgupta, Prabal Roy Chowdhury

SERI Working Paper No. 17

Abstract: This paper provides a rationale for one of the widely practiced mechanisms by MFIs – simultaneous borrowing and saving. Unlike the existing literature, our explanation does not involve any behavioral aspect. We study a dynamic relationship between a benevolent MFI and a strategic borrower. The optimum contract involves simultaneous borrowing and saving – at each date, the MFI provides a small loan, the borrower invests that in a productive technology, and saves the net return with the MFI. These help her to accumulate a lumpsum amount and “graduate” to an improved lifetime utility which is not achievable when only credit is provided. Over time, as her savings increase, her incentive to repay increases. The optimal loan scheme is weakly progressive i.e. weakly increasing over time. We also relate our analysis to the well-known non-existence result of Bulow and Rogoff (1989) and Rosenthal (1991).