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Contractual Flexibility, Firm Growth, and Information Asymmetries in Credit Markets: Experimental Evidence from Bangladesh

Contractual Flexibility, Firm Growth, and Information Asymmetries in Credit Markets: Experimental Evidence from Bangladesh

By Marianna Battaglia, Selim Gulesci, Andreas Madestam

 

Summary and Key Findings

 

Experimental studies on microfinance show that loan demand remains low despite the large number of organizations offering credit. Moreover, borrowing firms and households fail to see substantial increases in terms of business growth or consumption. One explanation may be found in the details of the credit contracts and recent research suggests that the effectiveness of microfinance (in terms of business outcomes) can improve if contracts are altered. However, most evidence on the impact of changing the terms of credit contracts is based on varying them for existing or previous borrowers, ignoring the possible effects on new clients.

 

In this project, we aim at understanding the full impact of introducing a more flexible loan contract on the credit market and on the growth of SMEs by addressing the following questions:

 

  1. What are the direct effects of introducing greater repayment flexibility in business loans on borrowers’ repayment behavior and business outcomes?
  2. Are there selection effects of introducing a loan contract with greater repayment flexibility on an MFI’s pool of borrowers?
  3. If offered to clients with a good credit history, can a flexible‐repayment loan contract be used as a tool to reduce moral hazard problems within the MFI’s current and future client base?

 

We will examine these issues together with BRAC in Bangladesh. BRAC, one of the largest microfinance institutions in the world, has decided to pilot a new loan product with greater repayment flexibility (henceforth, the “flexible contract”) targeted to SMEs in Bangladesh. The new, flexible loan contract will allow borrowers to delay 2 repayments within their loan cycle. BRAC is offering this flexible contract to borrowers with a good credit history. We are working with BRAC to evaluate the direct and indirect effects of the new loan contract through a cluster randomized control trial methodology. We are collecting a panel data of firms who are BRAC’s current borrowers and deemed eligible for the new flexible loan contract (eligible firms), firms who are current borrowers but not eligible for the new contract (ineligible firms), and a representative sample of firms currently not BRAC borrowers (non‐borrower firms). By comparing the changes in relevant outcomes of firms in the three groups in treatment versus control clusters, we will identify the causal effects of the new contract on the eligible firms, as well as the indirect effects on the ineligible firms and on non‐borrower firms.