Simultaneous borrowing and saving in microfinance

Abstract This paper provides a rationale for one of the most widely practised mechanisms by microfinance institutions (MFIs)—simultaneous borrowing and saving. Unlike existing literature, our explanation does not involve any behavioral aspect. We study dynamic relationship between benevolent MFI borrower who is subject to an ex post moral hazard problem. The optimum contract involves simultaneous saving—at each date, small loan, invests that in production technology, saves net return with MFI. These help her accumulate lumpsum amount ‘graduate’ improved lifetime utility which achievable when only credit provided. Over time, as savings increase, incentive repay increases. optimal loan scheme weakly progressive, i.e. increasing over time. also provide sufficient condition non-existence compatible contract.