Issue #6 December 2007
Variable Repayment Schedules & Default: The Effects of Introducing Flexibility into Microfinance Contracts A schism exists in microfinance between academics – who believe that microfinance can only stand to gain from greater flexibility – and practitioners – who are reluctant to introduce greater flexibility in contracts for fear of increased client default and delinquency. Over the past year, Professors Erica Field and Rohini Pande and the Centre for Micro Finance (CMF), in conjunction with the Village Welfare Society (VWS), a microfinance institution (MFI) in West Bengal, have sought to rigorously test these contrasting views. A first intervention with VWS took place between April 2006 and June 2007 and randomly assigned different repayment schedules to first-time female borrowers in joint-liability groups. Clients could either be assigned to 1) the traditional weekly meeting and weekly repayment schedule; 2) a weekly meeting and monthly repayment schedule; or 3) a monthly meeting and monthly repayment schedule. It soon became clear that introducing greater flexibility had no discernible effects on client default or delinquency: The rate of default in all three groups was virtually identical. These results are discussed in greater depth in Field & Pande, 2007. However, over the course of the first intervention several other findings stood out as interesting and worth further research. How Microfinance Clients Make Use of Their Loans How clients make use of their loans has been an important question for any research on microfinance. From survey questionnaires, we ascertained that clients did not use their money for large upfront investments in productive capital. This finding defies conventional wisdom that suggests that clients use their loans to make productive investments. At the same time, there has recently been scepticism in the effica-
cy of microfinance because of widespread use of micro-loans for consumption. This discrepancy between what has been suggested and the ground reality motivated us to find ways to better design loan contracts so that clients can make the best use of loans. Social Cohesion Microfinance is different from traditional debt contracts in the frequency of their meetings and repayments. Frequent meetings and repayment are believed to teach clients financial discipline, as well as build cohesion within groups so that clients will turn to each other in times of need and lack of verifiable collateral. Practitioners argue that with less frequent meetings, groups will not be as comfortable with each other and, as a result, clients will be reluctant to ask for help in making payments. Due to the randomized nature of our intervention, we had a unique opportunity to test this proposition. We found, during the first intervention, that although clients that met more regularly had greater familiarity with fellow group members, this familiarity did not translate into greater financial reliance. Instead, clients relied on traditional networks for making payments – such as their husbands and family members – suggesting that group cohesion has a limited role to play in joint liability groups. We are still unsure whether this is a generalizable phenomenon as these clients were first time borrowers and, thus, receive the smallest loan size that VWS offers. The fact that clients did not turn to their group members in times of need might be due to the small loan size or the age of the group rather than different meeting schedules. Early Repayment Another salient – but unexpected – result from the first intervention was the differing rates of early repayment between meeting schedules. VWS has a policy that after 33 weeks clients are allowed to repay the entirety of their loan. Results from our first intervention revealed that clients that met more frequently were more likely to repay the entirety of their loan earlier, suggesting that some aspect of more frequent
Centre for Micro Finance at Institute for Financial Management and Research 8th Floor, West Wing, Fountain Plaza, Khaleel Shirazi Estate 31/2 A, Pantheon Road, Egmore, Chennai, 600 008, India Phone: (91) 44 4289 2725 | Fax: (91) 44 4289 2799 | Web: www.ifmr.ac.in/cmf
In This Issue Variable Repayment Schedules & Default By Emmerich Davies and Anup Roy Emmerich and Anup are CMF research associates. In addition to the VWS project, Anup is currently working on the smokeless chulha project in Orissa in collaboration with MIT. Emmerich joined CMF in October 2007. Pg. 1
Financial Inclusion Drive By Minakshi Ramji Minakshi is a CMF research associate. As a member of CMF’s SWAP (Sector-Wide and Policy Issues) team, she is currently working on projects that explore levels of financial literacy amongst microfinance clients and its effects on financial behavior. Pg. 2
Integrating the Poorest into Microfinance By Jyoti Prasad Mukhopadhyay Jyoti is a CMF research associate. He has been working with Bandhan on the Ultra Poor Project since August 2007. Prior to this project, he was managing a project to study financial needs of migrant workers. Pg. 3
Full Disclosure:
An interview with Kate McKee By Amy Mowl Amy is a CMF research associate. She is coordinating the panel survey on socio-economic mobility with Yale Economic Growth Center. Pg. 7
CMF Working Paper Summary: How do women in mature SHGs save and invest their money? By Lucie Gadenne and Veena Vasudevan Lucie and Veena were interns at the CMF this past summer.
CENTRE FOR MICRO FINANCE