One of the world’s leading general economics journals, The Review of Economic Studies, has published an article by our colleague Marianna Battaglia together with two other researchers Selim Gulesci from Trinity College Dublin and Andreas Madestam from Stockholm University.
Considered one of the top 5 journals in economics, the also known as REStud, has included this article in its latest issue, titled “Repayment Flexibility and Risk Taking: Experimental Evidence from Credit Contracts”.
According to the authors, 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 increased spending during the startup phase, and offers insurance, in case of fluctuations in income. In a field experiment among traditional microfinance clients and larger collateralized borrowers in Bangladesh, the researachers 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 improvements in the traditional microfinance clients’ business outcomes, driven by borrowers in the upper tail of the distribution.
In addition, the authors find a significant impact on socioeconomic status, combined with lower default rates. They show theoretically and empirically that these effects are induced 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.