This experiment studies the effects of flexible repayment schedules on borrowers’ investment levels, consumption, and loan default in the dairy industry.
Background
Most microfinance institutes (MFIs) offer loan products with fixed weekly or monthly repayment schedules. Fixed repayments, however, may not work for most clients, particularly if their income is subject to variations due to seasonal activities, business cycles, health reasons and other risks. KAS Foundation, for example, has a monthly repayment system for its self-help group (SHG) clients. Most rural clients of KAS work in the dairy industry and face lean seasons in milk production. Mixed monthly repayment schedules may not be optimal for them as they do not correspond to the flow of income in their households.
This study evaluated the benefits of tailoring repayment schedules to the dairy industry on the following variables: business income, productivity, household’s ability to smooth consumption and to face shocks, and repayment rates.
Approach
This study conducted an experiment using a randomized design. In order to analyze the trade-off involved introducing flexible repayment schedules, the experiment compared two flexible loan products to the existing product of KAS for dairy clients. The first loan product allowed delayed payment by clients – by two principal instalments at any point of time in the loan tenure of 24 months. The second loan product allows clients to prepay six principal instalments during the lactation phase of cattle in order to enjoy flexibility in the later part of the loan tenure.
Key Findings
The findings suggested that the main channel through which flexible repayments affect income is higher returns to investment, i.e., more milk production for dairy farmers. But these benefits come at the expense of the lender, as defaults were considerable. The implementation of this experiment occurred just before the onset of the microcredit crisis in India, and thus there was difficulty ascertaining the full extent of the trade-offs, and the long term consequences, as the microlender ceased its operations.
Implications
Products with flexible repayments can lead to welfare improvements for borrowers, specifically to higher household income, and more diversified income as well as reduced vulnerability to shocks to dairy farmers. This experiment can also shed light on the impact of loan size on investment, that is, if credit constrains were tightened, does it lead to lower investments. Further, matching repayments to fluctuating income streams could be of tremendous importance for microcredit clients whose income is usually characterized by high volatility from seasonal production, production cycles or general high-risk environments, like for the dairy farmers in this study.