Contractual Flexibility, Firm Growth, and Information Asymmetries in Microfinance: Experimental Evidence from Bangladesh

The central aim of this project is to identify the impact of introducing a flexible loan contract on the credit market.

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Access to credit is an important engine of firm growth. Yet, despite the rapid expansion of microcredit organizations (MFIs) throughout the developing world, recent studies have shown that demand for microfinance remains low and borrowers fail to see substantial increases in terms of business growth. One explanation may be found in the swiftness of repayments demanded after loan disbursement. The inflexible nature of the standard microcredit contract may improve repayment behaviour but can also discourage profitable investments that require more flexible terms. Recently it has been shown that introducing a two-month grace period may substantially improve the effectiveness of microfinance contracts in terms of firm growth. If MFIs were to start offering a grace period contract as part of its lending portfolio, this would likely attract different types of borrowers. To fully evaluate the impact of changing the flexibility of microcredit contracts in terms of firms’ growth and default rates, it is key an understanding of the effects on existing microfinance clients, as well as non-borrowers.

The projects’ partner MFI (BRAC Microfinance) will pilot a new loan product that involves greater repayment flexibility made available to eligible borrowers with a good credit history. The introduction of the new contract at the BRAC branch-office level and the individual borrower level will be randomized. By comparing the characteristics of the new clients who decide to borrow in the treatment clusters with those that join in the control clusters after the introduction of the contract the researchers will test for selection effects of the flexible loan contract on the MFI’s client pool. They will then conduct follow-up surveys that will enable them to test for selection effects and to identify both the direct and indirect impacts of the new contract.

The results of the project will influence the way in which BRAC runs its microfinance operations directly. Furthermore, as BRAC is one of the central players in the microfinance sector, any impact on their microfinance programme is likely to influence other MFIs.