Do Flexible Repayment Schedules Improve the Impact of Microcredit? Evidence from a Randomized Evaluation in Rural India

Abstract

Microcredit institutions typically apply rigid and …xed repayment schedules when disbursing loans in order to reduce transaction costs, simplify procedures, and inculcate …scal discipline for better repayment behavior. Microcredit clients, however, often have neither smooth income nor singular moments in which to make lumpy investments throughout the year. This mismatch generates a cash ‡ow disconnect and, given the presumed liquidity constraints of the typical microcredit client, a potential welfare loss. Using data from a randomized evaluation with dairy farmers in rural India, we test the impact of ‡exible microcredit repayment schedules relative to "normal" in ‡exible, …xed repayment schedules. Although we are only able to track those who borrow, which introduces potential selection e¤ects, we …nd amongst those in ‡exible lending groups some evidence for higher ability to absorb shocks and higher income, which seems to be driven by limited improvements in investment and higher production from milk. On the cost-side, defaults do increase for the lender. Towards the end of the study, the microcredit market encountered crisis, with mass defaults, thus it is hard to generalize with respect to the default results. We conclude with caution, that we have shown suggestive evidence that a more ‡exible product design, one tailored to the needs of a dairy farmer, may be welfare enhancing for the dairy farmer. Further work is needed to both validate these results, and explore how to balance any trade-o¤ with default.

Flexible Microcredit: Effects on Loan Repayment and Social Pressure

“…Flexible repayment schedules for microloans are beneficial for borrowers. Compared to rigid repayment schedules, repayment flexibility has been shown to increase income by fostering investment in riskier and more profitable projects (Barboni and Agarwal 2018;Battaglia et al 2019;Czura 2015a;Field et al 2013). 1 Yet, microfinance institutions hardly ever offer flexible repayment schedules in practice.…”

“…The main argument brought forth is that rigid repayment schedules help create the necessary repayment discipline (Armendáriz and Morduch 2010;Labie et al 2017;Meyer 2002). Field experiments suggest that repayment flexibility may both increase default rates (Czura 2015a;Field et al 2013) or reduce them (Barboni and Agarwal 2018;Battaglia et al 2019). Both higher and lower levels of default have been attributed to the high-risk high-return investments that flexible loans facilitate.…”

“…Throughout this paper, we use 'repayment flexibility' for contracts which allow discretion in when to repay, and thus enable the borrower to condition repayments on shock realizations (see e.g. Battaglia et al (2019) and Czura (2015a)).…”

Repayment under Flexible Loan Contracts: Evidence from Tanzania

“…reducing installment frequency or allowing to delay an installment). The evidence is mixed: while overall higher flexibility seems to increase business profits, some studies also find an increase in default as borrowers invest in riskier projects (Field and Pande 2008;Field et al 2013;Czura 2015;Barboni and Agarwal 2018;Battaglia et al 2018).…”

Implicit and Explicit Commitment in Credit and Saving Contracts: A Field Experiment

“…The evidence on the impact of flexibility on repayment quality in microfinance contracts is similarly mixed, with recent contributions showing that flexibility is valued, leads to improved business outcomes, and does not increase default(Battaglia et al, 2018;Barboni and Agarwal, 2018), and other papers providing evidence to contrary(Field and Pande, 2008;Czura, 2015).…”