Demand for Flexibility in Microfinance Loans: Evidence from India

Microfinance loans have expanded greatly in the recent years as a way of helping the poor gain cheaper loans, but percentage take-up of microcredit has remained lower than expectations. In an attempt to explain this phenomenon, this paper uses a randomized evaluation of the impact of introducing microfinance loans in a new urban setting in Hyderabad, India, to determine if lack of flexibility in microfinance loans can be an answer to the problem. Using wages and sales volatility as proxies of demand for flexibility, this paper explores whether people are behaving as if microfinance loans are too stringent for their needs. The findings are consistent with the fact that there is some demand for more flexibility in microcredit, especially among business owners, but there also seems to be some surprising differences in terms of stratification according to education. For the high-education people, increasing sales volatility is associated with less take-up of microfinance loans, but for the low-education people, increasing volatility is correlated with more take-up of microfinance loans. This introduces the potential that microfinance institutions are missing out on the most profitable clients in the market. Dividing the population according to a measure of risk-averseness did not have a conclusive impact. ∗A very special thanks to Professor Cynthia Kinnan for serving as the faculty advisor for this thesis and helping me through all the difficulties. I would also like to mention Keyoung Lee for helping me identify the topic of interest and my parents for their feedback on the microfinance issues.