DP13329 Repayment Flexibility and Risk Taking: Experimental Evidence from Credit Contracts

Author(s): Marianna Battaglia, Selim Gulesci, Andreas Madestam
Publication Date: November 2018
Date Revised: December 2018
Keyword(s): credit, entrepreneurship, Insurance, Microfinance, Repayment flexibility
JEL(s):
Programme Areas: Development Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13329

A widely-held view is that small firms in developing countries are prevented from making profitable investments by lack of access to credit and insurance markets. One solution is to provide repayment flexibility in credit contracts. Repayment flexibility eases both the credit constraint, as it allows for increased spending during the startup phase, and offers insurance, in case of fluctuations in income. In a field experiment among microcredit borrowers in Bangladesh, we randomly assign the option to delay up to 2 monthly repayments at any point during a 12-month loan cycle. The flexible contract leads to substantial (0.2 standard deviation) improvements in business outcomes and socio-economic status, combined with lower default rates. The results are driven by an increase in entrepreneurial risk taking, implying that the primary mechanism is insurance provision. Repayment flexibility also attracts less risk-averse borrowers. Our findings suggest that lack of insurance is an important constraint for small firms but that a simple financial product that increases repayment flexibility can be an effective tool for enabling enterprise growth.