Independent Research and Policy Advocacy

Flexibility in Microfinance Loan Contracts

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Microfinance institutions typically offer group loan and individual loan products that have standardized repayment structures. These reduce transaction costs, simplify product complexity and ensures repayment discipline amongst borrowers. The repayment schedules of these loan products are characterized by early commencement of the instalments, wherein the first instalment can be anytime between one week to one month after the disbursement of the loan. While a fixed and predefined repayment schedule helps the process of collection for the lending institutions and the mental accounting for borrowers, it also poses a problem when there are volatilities in the value and timings of the cash flow in the household due to seasonal activities, business cycle stages, health shocks and other factors. To put a layer of rigidity on an otherwise volatile cash flow can aggravate the liquidity position of the household. The fixed repayment schedule can affect investment choices and discourage projects that take longer to realize returns. This research note discusses the scope of flexible loan contracts and presents several options on how flexibility can be introduced into these loan contracts, with some evidence from the literature.

To read the full research brief click here.

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