Financiers across the world structure debt contracts to limit the risk of entrepreneurial lending. But debt structures that reduce risk may inhibit enterprise growth, especially among the poor. Using a field experiment we quantify the short- and long-run tradeoffs associated with the classic microfinance debt contract. We contrast the classic contract which requires that repayment begins immediately after loan disbursement with a contract that provides a two-month grace period before repayment begins. The shift to a grace period contract increased short-run business investments and long-run profits, implying average return to capital of over 8% per month. However, we also observe a significant increase in the variance of profits and a tripling of default rates. In this manner, early initiation of repayment reduces risk to financiers but also reduces the potential impact of microfinance on microenterprise growth and household poverty.
Field, E.; Pande, R.; Papp, J.; Rigol, N. Term Structure of Debt and Entrepreneurship: Experimental Evidence from Microfinance (IGC Working Paper). International Growth Centre (IGC), London, UK (2011) 42 pp.