A Study on Repayment Flexibility, Contract Choice and Investment Decisions Among Indian Microfinance Borrowers

This study examines the impact of introducing repayment flexibility in microfinance contracts.

Despite the pervasiveness and success of microfinance initiatives in developing countries, they are thought to have had little effect on helping entrepreneurs grow their businesses. This is partly attributed to rigid and frequent repayment plans which force borrowers towards low-risk and low-return business activities. Strict repayment schedules may constrain entrepreneurs from taking risks in long-term and riskier projects, resulting in poor growth of their enterprises. This study was undertaken to observe whether flexibility in repayment can have an impact on production growth, employment and income. How preferences for repayment flexibility relate to customer’s characteristics and business will also be studied. To this end, the study has been set up as an RCT with a randomly selected group of microfinance borrowers under the individual-lending methodology being offered the possibility to choose between a flexible and a rigid repayment structure, although the rigid contract allowing for a lower degree of flexibility, will be cheaper and will require less collateral from the clients than the flexible one.

Researchers, in collaboration with the microfinance lender Sonata (P) Ltd, designed a flexible contract that allowed borrowers to waive repayments during the loan cycle and to exercise this option whenever they needed it the most. The research study is set in the Indian state of Uttar Pradesh, spread across both city and non-city areas. The division of the sample across city and non-city branches allows the researchers to understand the differences in the household characteristics and demographics which could explain possible differences in take up of the flexible or rigid loan and thereby differences in the client’s business psyche. Data was collected on a total of 800 randomly selected households that were first time individual-loan clients, 400 of whom have received the treatment intervention.
With the sample distributed across 28 branches of the partner institution, the branches were randomly assigned to treatment and control with 14 branches in each group. The total sample of 800 borrowers was divided proportionally across branches using the number of monthly loans disbursed at each of branches.

Findings indicate that borrowers who carry out higher-revenue activities were more likely to take up the flexible schedule than borrowers engaged in lower-revenue activities, even when the flexible schedule is more expensive than the rigid one. On the contrary, it was observed that risk-averse borrowers were more likely to persist with the rigid contract when it was cheaper than the flexible contract. From a policy perspective, the study shows that borrowers’ characteristics can be predictive of flexible contracts’ take-up rates. It demonstrates how innovations in microfinance are key to development challenges by spurring small business growth. Results from this study have also contributed to emerging literature and evidence on introducing more flexibility in microfinance contracts.

Thematic Area

Financial Well-being and Social Protection

Project Leads

Giorgia Barboni, Parul Agarwal


Uttar Pradesh


Sonata Finance (P) Ltd.