Designing Microfinance to Enable Consumption Smoothing: Evidence from India
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Field, Erica; Pande, Rohini; Park, Y. Jeanette
[Excerpt] This paper focuses on a key aspect of microfinance contracts - repayment schedules - to determine the impact of greater flexibility in repayment schedules on clients’ ability to smooth consumption as well as increase income by putting their loans in less liquid but higher return investments. Traditionally, microfinance repayment schedules are notoriously rigid, involving high frequency repayment in small installments beginning soon after loan disbursement, an important aspect of the lending model pioneered by earliest MFIs such as the Grameen Bank (Armendariz and Morduch 2005). However, in theory, clients are likely to be better off under more flexible repayment terms, which would give them greater ability to smooth consumption in the face of unanticipated shocks and encourage them to invest more of the loan in relatively illiquid but potentially higher return business investments (Field and Pande 2008). Through both of these channels, introducing flexibility in the timing of repayment by reducing repayment frequency could increase client long-run business income.
India; microfinance; consumption smoothing