Community-Mediated Exchange and Collective Loan Defaults in Microfinance : Evidence from Indian Demonetization

Firms serving base-of-the-pyramid markets often employ community-mediated exchange strategies that build and maintain exchange relationships with customers collectively, through community interactions. Prior research suggests that such strategies may engender positive peer influence that leads customers to collectively fulfill exchange obligations. However, we argue that community-mediated exchange can also have an opposite, adverse effect when systemic economic distress affects an entire community of customers simultaneously. We test this proposition through a quasi-experimental design leveraging India's 2016 demonetization policy, a shock that revoked the legal tender status of 87 percent of the country's currency in circulation and imposed significant economic hardship on its population. Using proprietary data on approximately two million borrowers from a leading Indian microlender, we find strong evidence suggesting that a sharp increase in loan default rates following demonetization was a collective phenomenon shaped by peer influence within community-level microfinance lending centers. Post-demonetization, all borrowers defaulted (“collective default”) in 21.6 percent of centers, compared with just a 3.7 percent collective default in a simulated scenario in which individual defaults were equally common, but determined through independent individual-level decisions, absent peer influence. Further, the likelihood of collective default was greater in centers with greater homogeneity of borrower religion and lending cohort, both likely indicators of peer relationship strength. Our findings contribute to research on community-mediated exchange strategies by showing how their consequences for firms may differ according to external and social conditions