Contracts for Credit Secured by Digital Collateral

A key challenge facing retail sales of durables in low- and middle-income countries (LMICs) is access to consumer financing. Microfinance remains the predominant source of credit to poor households, but microfinance loans suffer from low repayment, partly due to being unsecured. Recent technological advances have allowed private sector retail firms to offer financing to households secured by "digital collateral,” which helps overcome economic frictions in credit markets (Gertler et al., 2021). Digital collateral exploits new lockout technology that can be used to disable electricity-using assets, such as solar home systems and smart phones, remotely and cheaply in the case of nonpayment, and which can also be quickly reversed once payment resumes. While the innovation appears promising, little is known about how to design the contract. In this project, we will investigate the two leading candidates in the context of solar home retails sales: pay-as-you-go (PAYGO) financing versus a more traditional loan contract (ARREARS). PAYGO financing offers households more flexibility, but reduces incentives for timely repayments, raising concerns about its economic sustainability. Meanwhile, the ARREARS loan contract offers stronger incentives for regular usage and repayment, but may be unattractive to households with irregular or uncertain income. Our findings will have important implications for how digital financial service providers can structure contract terms to expand sustainable financing of retail sales of durable goods in LMICs.