Risks, Returns, and Relational Lending: Personal Ties in Microfinance

Abstract

Personal relationships are a common feature of financial intermediation. However, existing research offers different expectations about whether personal ties prove detrimental or beneficial for lenders. Research on embeddedness from economic sociology highlights the advantages lenders accrue when they develop personal ties with borrowers, including enhanced trust, information-sharing and greater social control. Yet research from social psychology offers reason to suspect that personal relationships can be costly because lenders who feel personally tied to borrowers run the risk of escalating commitment to poor performers. Drawing on these lines of research, this study uses data from a Latin American microfinance bank to ask: When are personal relationships detrimental or beneficial for financial intermediaries? It shows that, when lenders and borrowers have personal relationships, lenders are less likely to cut ties with poor performers and borrowers miss fewer payments, consistent with expectations from both literatures. However, these trends vary with frequency of contact. When lenders and borrowers interact less frequently, lenders continue to show heightened commitment, but borrowers become less compliant, creating potential problems for lenders. Overall, this study integrates theories from economic sociology and social psychology to offer a more balanced, temporally-informed understanding of personal ties in finance. Forthcoming at American Journal of Sociology.I am grateful to Mario Small, Elizabeth Pontikes, Rodrigo Canales, Richard Taub, and Ray Reagans for reading multiple drafts of this manuscript and providing continued support. I am also grateful for helpful comments from Anne Bowers, Jillian Chown, Jan Doering, Matissa Hollister, Sarah Kaplan, Chris Liu, Bill McEvily, Elena Obukhova, Jayanti Owens, Amanda Sharkey, András Tilcsik, Tiantian Yang, and Peter Younkin, as well as from seminar audiences at Brown, Chicago, Columbia, London Business School, Lugano, New York University, Princeton, and the University of Toronto. Finally, my deepest thanks to MicroBank administrators, loan officers, and clients for making this study possible. 2Scholars across a range of disciplines recognize the importance and pervasiveness of personal relationships in the financial sector (Abolafia 1996;Berger and Udell 1995;Mizruchi and Stearns 2001;Petersen and Rajan 1994). In lending institutions, personal ties between financial intermediaries (lenders) and clients (borrowers) influence how banks distribute capital and overcome information asymmetries (Berger, Klapper, and Udell 2001;Uzzi 1999) Existing research on embeddedness and escalation suggests that personal ties between intermediaries and clients can be both beneficial and problematic for financial intermediaries.However, the specific conditions under which these relationships prove more helpful or harmful remain unclear. In this paper, I aim to clarify these conditions and, in so doing, integrate distinct theoretical perspectives from social psychology and ...

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“…Assuming different notions of trust -or any definition in particular-most studies on relational lending assume that personal interaction between clients and loan officers generates somehow a trusty relationship. In explaining how trust emerge in this case, some argue that is a result of repeated interactions where participants´ values and objectives become mutually understood and intertwined (Saparito et al, 2004), or an effect of the frequency of contact as a measure of the tie´s strength (Doering, 2018), or also the duration of the relationship over time (Shahriar and Garg, 2017). In spite of the differences about what causes trust, they share a common point of view that is: levels of trust are higher in the cases where there are strong relationships between lender and borrower-entrepreneur (Howorht and Moro, 2006).…”

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