Repayment Flexibility and Risk Taking: Experimental Evidence from Credit Contracts

106 Pages Posted: 26 Nov 2018 Last revised: 14 May 2021

See all articles by Selim Gulesci

Selim Gulesci

Bocconi University - Department of Economics

Andreas Madestam

Stockholm University, Department of Economics

Date Written: November 2018

Abstract

A widely held view is that small firms in developing countries are prevented from making profitable investments by lack of access to credit and insurance markets. One solution is to provide repayment flexibility in credit contracts. Repayment flexibility eases both the credit constraint, as it allows for a higher investment return, and offers insurance, in case of fluctuations in income. In a field experiment among traditional microfinance clients and larger collateralized borrowers in Bangladesh, we randomly assign the option to delay up to 2 monthly repayments at any point during a 12-month loan cycle. The flexible contract leads to substantial (0.2 standard deviation) improvements in the traditional microfinance clients' business outcomes and socioeconomic status, combined with lower default rates. We show theoretically and empirically that these effects are driven by an increase in entrepreneurial risk taking, implying that the primary mechanism is insurance provision. Repayment flexibility also attracts less risk-averse borrowers interested in business expansion. At the same time, the effects for the larger loan are much more modest. Our findings suggest that lack of insurance is an important constraint for small firms but that a simple financial product that increases repayment flexibility can be an effective tool for enabling enterprise growth.

Suggested Citation

Gulesci, Selim and Madestam, Andreas, Repayment Flexibility and Risk Taking: Experimental Evidence from Credit Contracts (November 2018). CEPR Discussion Paper No. DP13329, Available at SSRN: https://ssrn.com/abstract=3290521

Selim Gulesci (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Andreas Madestam

Stockholm University, Department of Economics ( email )

Universitetsvägen 10
Stockholm, Stockholm SE-106 91
Sweden

HOME PAGE: http://www.ne.su.se/andreasmadestam

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