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Credit risk is a reality for banks around the world. It is even a fairly predictable reality, if sometimes ignored (Exhibit A: Present dynamics in the US). Banks often know what percentage of their loan portfolio is at risk and they price that risk through higher interest rates for riskier clients, among other ways. Microfinance institutions (MFIs) do not have the same luxuries. They lack the information about their clients necessary to differentiate, they already get enough flak about their “high” interest rates, and they are constantly fighting to keep operations costs low, a difficult task if you increase complexity. It’s no wonder, then, that low client default rates have become a kind of holy grail for microfinance providers. When you feel powerless to change so much of what you do, its useful at least to have a clear measure of commercial success.

And yet, could the rigidity of the typical micro-credit product be partially responsible for the fact that access to credit has limited, if any, income effects for micro-entrepreneurs? Could it be that microentrepreneurs are intentionally shying away from higher risk, higher return investments because the banks require that they begin paying back the loan within a week after they receive it? That was the operating question for a study presented at the Microfinance Impact and Innovation Conference by Erica Field from Harvard.

To recap, the traditional micro-credit loan is offered to women in a group liability structure; the loans are typically given with the intent that the women will either start or continue to support a business. The women meet once a week with the loan officer to make payments, and those payments start the first week after the loan is given. (A number of studies have shown that moving to monthly meetings and repayment does not effect default rates. Field conducted one such study in India, and the participating bank changed its loan structure as a result, since it saves in operations costs. That same bank is the partner in this study presented by Field as well.)

Field looked to the developed world for a model: In the US, small business loans typically have a “grace period” of at least a few months before the business owner is required to begin loan payments; those payments also typically occur in a monthly cycle, not weekly; and the default rates are much higher than micro-credit defaults (between 13 and 15 percent default compared to the 4 or 5 percent default seen from microfinance clients). With that approach in mind, Field worked with a Village Welfare Society in India to implement a credit product that introduced a two-month grace period after the loan was dispersed and before the client needed to start paying.

The results showed that clients with the two-month grace period on average enjoyed 25 percent higher profits than clients in the control group. They invested 10 percent more of the loan in the business, and increased inventories and outputs by two thirds. Household income also seemed to increase in the period.

Those numbers imply that increasing flexibility in loan terms has positive effects for some micro-credit recipients. Yet the study showed some important nuances. Most relevantly is that the results varied widely—a group of recipients with grace periods did dramatically better, but some did dramatically worse (that 25 percent increase in profits is only the average). In addition, defaults for the bank increased, reaching 12 percent of the “grace period” group, compared with slightly more than 4 percent for the control.

The outcome? Field reports that the bank does not plan to implement grace periods for its microenterprise clients. Why would it? It would amount to taking more risk and earning less in order to help some clients earn more.

But don’t write off this study yet. Given the puzzle of helping microentrepreneurs increase incomes, it is worth exploring how banks can identify those more likely to succeed from those more likely to fail and introduce the two-month grace periods for the former group. Such easy-to-use measures might be a win for everyone. More on that subject in coming posts. Stay tuned…


Grameen Bank (most MFIs follow Grameen Model) instituted the requirement [for immediate weekly repayments] to protect the loan amount from social demands and to prevent the borrowers from using it for non-productive usage. The poor have limited financial leverage and as the book Portfolio of the Poor shows, they use complex financial transactions to keep their noses above water. Any extra cash in their hands will be subject to demand by family members and the extended family. Moreover, they can also use up the cash instead of investing it in business ventures. To protect the members, Grameen Bank instituted the requirement for installment payment within the first week of loan disbursement. The high default rate rate with grace period vindicates Grameen Bank.

October 26, 2010


actually I would argue that the study refutes the Grameen model in important ways. What Field showed is that with longer grace periods, it was more likely that the money borrowed would be put to productive use by investing in businesses or equipment with much higher potential returns. But as in all of life, to get greater returns you have to take more risk. Therefore some will fail and the failure will have greater negative consequences.

The Grameen model, with its insistence on immediate repayment, may protect the borrowers from social demands. But it also ensures that the money can only be put to low risk and low return uses. That, as the 3 high quality studies of microcredit impact show, means that on average the loans are NOT put to very productive use. They simply become household financial management tools that make life easier for the poor but don’t have much impact on income, consumption or business investment. That’s not a bad thing, but its certainly not what Grameen and its followers intended.

October 26, 2010

But she also shows that the default rate is higher for the group with a grace period, and [typically] the institution is not allowing a grace period. I think it supports Grameen Model. I am not saying that Grameen was right to do put in that stringent condition. As you may be aware Grameen has restructured its model because it found the old model to be too rigid. But they have still kept the immediate repayment requirement.

Everyone, including the supporters of randomization, points out that a major weakness of these studies is that the results are not applicable in different settings. Take the Indian study. It is based on an MFI in urban areas. That is totally different from rural India. And the fact that the three famous studies shows limited impact does not mean MFIs in other countries have no impact as well.

October 26, 2010


I agree that Field’s results validate the connection between immediate repayment and ultimate default rates. But it also undermines the ultimate purpose of Grameen, which was most certainly not high repayment rates. It was the idea that these loans would allow women to invest and generate the income necessary to propel them out of poverty.

My reading of Field’s experiment is that one of the product design features that increases the likelihood of repayment (in other words, reduces default), decreases the ability of borrowers to invest and generate sufficiently high returns. The model is ultimately in conflict with itself.

In terms of applicability of the study, of course we have to be cautious about applying the results of one study not only in other contexts but also in the same context. One study should not propel dramatic changes in product design.

That being said, the fact that Field’s study and the impact studies of Duflo, Banerjee, Karlan and McKenzie in very different contexts show broadly similar things, and they align very well with the research in Portfolios of the Poor, and they match observations about returns and growth in microenterprises in many different contexts should drive us to beginning our thinking from a very different set of assumptions than have historically been applied to microfinance.

October 27, 2010

I think you are both pretty much right. Asif is right that the study validates one design choice in the Grameen credit mechanism, immediate repayment, in the sense that delayed repayment does appear to threaten the viability of group microcredit as a business proposition. This is not too surprising because Yunus and his early students, maybe including Asif, experimented a lot before settling on the class Grameen model. On the other hand it does not go without saying, since the Grameen Bank has found it possible to dispense with other conservative aspects of the original model. Grameen borrowers can now “top-up” loans, offering a form of flexibility that is not yet, um, Field-tested. And, Asif informs me, that Grameen has dropped all forced savings requirements.

Now, purposes reside in people, not mechanisms. There can be as many purposes as people. So I hesitate to speak of “the purpose” of the Grameen model. Certainly, it was pitched as supporting microenterprise. It’s possible that pitch came after the model was refined, an adaptive response to the environment like immediate repayment itself. In other words, that pitch brought in the funds. And Field’s results do suggest microcredit was not really optimized to support microenterprise, undercutting this story. But really, this is not a surprise. Microcredit is designed above all to solve the problem of delivering credit in bulk to the poor without losing one’s shirt. It is significant that the microcreditor that implemented the experiment declined to take up the innovation permanently. As imperfect as standard microcredit is for microenterprise, it might be of even less use if it bankrupts the microcreditors.

October 27, 2010

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