Using survey data on micro and small enterprises in Uganda, this study investigates the phenomenon of ‘adverse selection’ in credit markets – i.e. the presence of high-risk, low-return borrowers in the client base of microfinance institutions. Hypothetical loan demand questions are used to test whether firms respond to changes in loans’ contractual terms and whether take-up varies by firms’ risk type. The results indicate that lower interest rates and less stringent collateral requirements are likely to attract safer borrowers, suggesting that the terms dictating standard financial contracts have scope for improvement.
Gulesci, S.; Madestam, A.; Stryjan, M. PEDL Research Note. Contractual Structure, Borrower Selection, and Hypothetical Loan Demand: Survey Evidence from Uganda. Centre for Economic Policy Research (CEPR), (2014) 3 pp.