Does the Classic Microfinance Model Discourage Entrepreneurship Among the Poor? Experimental Evidence from India

TLDR

The study asks whether classic microfinance repayment terms deter poor borrowers from investing in high‑return, illiquid ventures. A field experiment contrasts a classic immediate‑repayment contract with a two‑month grace‑period contract. The grace period boosts short‑term business investment and long‑term profits but raises default rates, showing that early repayment discourages risky, illiquid investment and limits microfinance’s impact on growth and poverty. JEL codes: A21, G32, I32, L25, L26, O15, O16.

Abstract

Do the repayment requirements of the classic microfinance contract inhibit investment in high-return but illiquid business opportunities among the poor? Using a field experiment, we compare the classic contract which requires that repayment begin immediately after loan disbursement to a contract that includes a two-month grace period. The provision of a grace period increased short-run business investment and long-run profits but also default rates. The results, thus, indicate that debt contracts that require early repayment discourage illiquid risky investment and thereby limit the potential impact of microfinance on microenterprise growth and household poverty. (JEL A21, G32, I32, L25, L26, O15, O16)