Microfinance: Debt and Risk

Debt Structure, Entrepreneurship, and Risk: Evidence from Microfinance

June 6, 2012

Speaker: Professor Erica Field, Duke University

Professor Field’s research is motivated by barriers to entry/business expansion in microfinance due to traditionally restrictive repayment schedules. Many microfinance institution (MFI) loan repayment schedules begin within two weeks of initial disbursement. Field and her colleagues conducted a randomized-control trial in India with the treatment applicants receiving a two-month grace period before loan repayments began and the control applicants following the typical repayment plan. The survey design originated out of qualitative research showing demand from microfinance loan recipients for a grace period before the beginning of loan repayments.

In comparison to the control group, households with an initial grace period responded positively to the more flexible loan terms. In the short run, individuals in the treatment group invested 6% more of their loans in business-related activities. At the three-year follow-up survey, households provided with the initial grace period experienced 18-20% greater business profits in comparison to the control group. While businesses in the treatment households were significantly larger, they were also significantly more likely to default on their loans and had greater variability in their business profits. Field suggested that policymakers should refocus their microfinance attention away from interest rate caps and more toward loan contract flexibility. She also pointed out that for microfinance to encourage transformational entrepreneurship, MFIs should expect to see higher default rates on these inherently riskier investments.

David Roodman, Senior Fellow, Center for Global Development, followed Field's presentation with an engaging discussion of the findings. He commended the study for its longer-term focus and inclusion of qualitative motivational background research. Roodman requested more information on the distribution of the variation in average business profits, in questioning the extent of the entrepreneurial losers (defaulters). He also desired a cost-benefit analysis of the profitability of this loan restructuring for MFIs, in questioning if incorporation of a grace period would be self-financing or should be considered for future subsidization.

Seminar participants inquired about heterogeneity in risk preference within the borrowers. Field addressed these issues and hopes to incorporate some of the questions into the work.

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