Does the Classic Microfinance Model Discourage Entrepreneurship Among the Poor? Experimental Evidence from India
Adding a two-month grace period in microfinance loan repayments, rather than the traditional immediate repayment model, may increase default rates, but it also leads to more micro-enterprise investment, a greater likelihood of starting a new business, and higher profits three-years later for poor women in Kolkata.
Cite this Article
Field, Erica, et al. "Does the classic microfinance model discourage entrepreneurship among the poor? Experimental evidence from India." The American Economic Review 103.6 (2013): 2196-2226.
Field, E., Pande, R., Papp, J., & Rigol, N. (2013). Does the classic microfinance model discourage entrepreneurship among the poor? Experimental evidence from India. The American Economic Review, 103(6), 2196-2226.
Field, Erica, Rohini Pande, John Papp, and Natalia Rigol. "Does the classic microfinance model discourage entrepreneurship among the poor? Experimental evidence from India." The American Economic Review 103, no. 6 (2013): 2196-2226.
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This article was written by , , and , and was originally published by American Economic Review in October of 2013There is growing evidence that microfinance, which has expanded rapidly from its roots in Bangladesh in the late 1970s, has mixed success in growing microenterprises and alleviating poverty. One reason for its failure to grow microenterprises could be its classical repayment model, which requires repayment to begin one or two weeks after receiving a loan. These structured debt contracts are an important means to limit lending risk, particularly to poor entrepreneurs, and as a result, have very high repayment rates. The immediate repayment contracts, however, may inhibit entrepreneurship by discouraging risky investments – thereby limiting the potential impact of microfinance on microenterprise growth and household poverty. This study compares the classic microfinance contract that requires that repayment begin two weeks after loan disbursement to a contract that includes a two-month grace period, in order to examine whether the classic microfinance contract inhibits investment in high-return business opportunities among poor women in Kolkata, India.
The introduction of a two-month grace period in the microloan contract led to a positive change in economic activity among poor women in Kolkata, India.
- Micro-enterprise investment was 6% higher among clients who received the two-month grace period contract relative to those who received a regular contract.
- Clients who received the grace period were approximately three times as likely to start a new business than those who received a regular contract. Only 1.8% of regular contract clients started a new business within 6 months of the loan dispersal, while 2.7% of clients who received the grace period contract started a new business during this time period.
- Nearly three years after receiving the loan, weekly business profits were 41% higher and monthly household income was 19.5% higher among clients who received a grace period on their loans. These clients also reported 80% more business capital.
- Grace period clients were 7.2 percentage points less likely to report a business closure between loan disbursal and the three-year follow-up than regular contract clients.
- Clients that received a grace period experienced heightened risk-taking. In the short run, they were three times as likely to default than regular clients. But three years after receiving their loans, they were more likely to extend credit to customers through loans and pre-orders and to offer a wider array of goods and services.
In short, the classical models of microfinance repayment contracts, which require immediate repayment of a loan, may simultaneously limit default but also the potential impact of microfinance on microenterprise growth and household poverty.
This study was conducted with Village Financial Services, a micro-finance institution that makes individual-liability loans to women in low-income neighborhoods of Kolkata, India. Between March and December 2007, 169 loan groups of five clients (giving a sample of 845 clients) were randomly assigned to one of two debt contracts: Clients assigned to the control group received a standard contract that required them to initiate repayment two weeks after receiving their loan. Clients assigned to the treatment group received a two-month grace period before repayment began. All loans were individual liability contracts, ranging in size from Rs. 4,000 (approximately $90) to Rs. 10,000 (approximately $225) with a modal loan amount of Rs. 8,000. Once repayment began, clients repaid at an identical frequency in group meetings conducted every two weeks. Both groups faced the same interest charges.
Cite this Article
Field, Erica, et al. "Does the classic microfinance model discourage entrepreneurship among the poor? Experimental evidence from India." The American Economic Review 103.6 (2013): 2196-2226.
Field, E., Pande, R., Papp, J., & Rigol, N. (2013). Does the classic microfinance model discourage entrepreneurship among the poor? Experimental evidence from India. The American Economic Review, 103(6), 2196-2226.
Field, Erica, Rohini Pande, John Papp, and Natalia Rigol. "Does the classic microfinance model discourage entrepreneurship among the poor? Experimental evidence from India." The American Economic Review 103, no. 6 (2013): 2196-2226.
