Separating the wheat from the chaff: Signaling in microfinance loans

We examine how microfinance borrowers might signal their repayment responsibility (i.e., borrower quality) by opting into (costly) life insurance purchase along with their micro-loans. We show empirically that borrowers who bought additional life insurance coverage were significantly more likely to fully repay their loan, and were allowed to receive higher loan amounts, even after controlling for borrower health and other determinants of loan repayment and insurance purchase. The relationship is stronger in magnitude for new borrowers' first loan than for their second loan, and in several situations in which borrowers would have a higher incentive to signal their creditworthiness. We interpret this evidence as borrowers signaling their creditworthiness (or quality) by purchasing costly insurance in an environment subject to a high level of information asymmetries and devoid of credible tools to demonstrate creditworthiness.