Does Microfinance Repayment Flexibility Affect Entrepreneurial Behavior and Loan Default?

Recent evidence suggests heterogenous impacts of microfinance loans, with limited average effects on enterprise growth among the poor. One possibility is that the rigidity of the classic microcredit contract – widely held to be important for reducing default – inhibits investment in microenterprises. To explore these trade-offs, we provide experimental estimates of the consequences for client repayment and investment behavior of introducing a grace period before repayment begins. Delaying the onset of repayment by two months significantly increases both business investment and default. Taken together, the results are consistent with clients on the delay cycle choosing investments with more variable returns. ∗The authors are from Harvard University (Field and Pande) and Princeton University (Papp). We thank Emmerich Davies, Sitaram Mukherjee and Anup Roy for superb field work, the Village Welfare Society and Center for MicroFinance for hosting this study and Theresa Chen, Annie Duflo, Nachiket Mor and Justin Oliver for enabling this work. We also thank Natalia Rigol for exceptional research assistance.