A new study published in the Strategic Management Journal uncovers a significant and often-overlooked risk in microfinance: while social capital fosters financial stability in normal times, it can exacerbate default rates during crises. The research, conducted by Arzi Adbi, Matthew Lee, and Jasjit Singh, examines the loan repayment behavior of nearly two million low-income borrowers in the aftermath of India’s 2016 demonetization policy, revealing the unintended consequences of peer accountability in financial markets.

Over the past fifty years, microfinance has been hailed as a revolutionary tool for financial inclusion, particularly through group-lending models. These models rely on social connections and peer accountability to encourage loan repayment among low-income borrowers. However, as this study demonstrates, the very mechanisms that drive repayment in stable times can accelerate default rates when external crises arise.

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