Households, Financial Distress, and Predatory Lending: An Experimental Study

Abstract

ABSTRACT A substantial part of households and micro enterprises, particularly in developing coun- tries including Indonesia, did not have access to formal financial institutions which then lead them to borrow money from illegal loan providers. Using an experimental study, we tested whether predatory loan, an illegal short-term loan with high interest rate, was preferable or not by comparing with pawnshop loan, bank loan and household’s limited saving when households confront with financial distress. We divided the participants into three groups: lower low, low, and upper low income. We found that predatory loan was preferable especially for lower low and low income group. Result also confirmed that even if the predatory loan charge was increased, the lower low- and low-income groups still prefer to ease their financial distress through predatory loans. Moreover, the longer the duration of the predatory loan, the higher its probability to be chosen as a funding source in times of household financial distress.