Making Microfinance Loan Programs Work Better for Clients

October 1, 2012
by Doug Gavel

CAMBRIDGE, MA – Flexible repayment schedules for microfinance loan recipients can reduce financial stress faced by individual clients. One important reason for this may be income gains due to improved business investments. That is the finding from a field experiment in India designed in part by Harvard Kennedy School Professor Rohini Pande, and reported in the September 26th edition of PLOS ONE,a peer reviewed, open access journal.
“Repayment Flexibility Can Reduce Financial Stress: A Randomized Control Trial with Microfinance Clients in India” is co-authored by Professor Erica Field, Duke University; Rohini Pande, Mohammed Kamal Professor of Public Policy, Harvard Kennedy School; John Papp, Highbridge Capital Management; and Y. Jeanette Park, Harvard Business School.
Recent criticism of microfinance institutions has focused on a perception that the poor are being allowed to take on too much debt – leading to significant financial stress. In some cases, this debt has been blamed for borrower suicides. Nevertheless, the poor need credit to grow businesses and insulate against shocks. This paper finds that the financial stress of debt can be significantly reduced, and business income doubled, on average, by increasing loan repayment flexibility.
The researchers worked in collaboration with a microfinance organization called Village Financial Society (VFS) in Kolkata, India to gauge clients’ responses to different loan repayment schedules with the intent of determining whether more flexible schedules reduced financial pressures and improved economic outcomes.
“The typical microfinance borrower faces a very rigid repayment schedule that requires her to make installments on a weekly basis beginning shortly after loan disbursement,” the authors write. “While such a contract is believed to be an important component of keeping default at bay, frequent repayment also limits clients’ ability to deal with short-term shocks to household income and could, therefore, be an important source of anxiety when there is a high degree of income variance.”
“A central concern is that the psychological burden of frequent repayment – particularly among poor clients who often lack the financial tools to optimally manage loans – may in many instances offset the positive influence of access to credit, making microfinance borrowers worse off in terms of mental well-being,” they write.
In the field experiment, some loan recipients were switched to a monthly repayment schedule, resulting in significant differences as compared to those on the weekly schedules:
• monthly clients were 51 percent less likely to report feeling ‘worried, tense or anxious’ about repaying than weekly clients;
• monthly clients were 54% more likely to report feeling confident about repaying their loan than weekly clients; and
• relative to weekly clients, monthly clients more than doubled their business income, on average;
• there was no evidence, however, that moving from a weekly to a monthly payment increased the default rate during the study period.
"The results show that flexibility in repayment reduced clients’ mental stress along several dimensions, suggesting that product design can play a key role in influencing how microcredit affects the financial stress of the poor," the authors conclude.
"We find little evidence that the less frequent payments affected social interactions, default, spending on temptation goods, or clients’ ability to smooth income," they write. "Rather, our results suggest that a schedule requiring less frequent payments leads to a reduction in financial stress because it enables clients to use their credit more wisely and take advantage of profitable investment opportunities, which results in higher household income."
These findings extend a growing experimental literature on microfinance. Previous work has shown that the existing microfinance contract increases indebtedness, but has little or no effect in reducing poverty. The authors suggest that improved contract structures should both allow clients to manage debt less with less stress, and to make significantly more profitable investment decisions.
Rohini Pande is the Mohammed Kamal Professor of Public Policy at Harvard Kennedy School and co-Director of Evidence for Policy Design (EPoD) at Center for International Development, Harvard University. Her research examines how the design of democratic institutions and government regulation affects policy outcomes and citizen well-being, especially in South Asia. Her work emphasizes the use of real-world evidence to test economic models, often through large-scale field experiments in developing countries.

Photograph of Professor Rohini Pande

Rohini Pande, Mohammed Kamal Professor of Public Policy

“The typical microfinance borrower faces a very rigid repayment schedule that requires her to make installments on a weekly basis beginning shortly after loan disbursement,” the authors write. “While such a contract is believed to be an important component of keeping default at bay, frequent repayment also limits clients’ ability to deal with short-term shocks to household income and could, therefore, be an important source of anxiety when there is a high degree of income variance.”

 


John F. Kennedy School of Government 79 John F. Kennedy Street
Cambridge, MA 02138
617-495-1100 Get Directions Visit Contact Page