Despite the popularity of microfinance, a growing body of research suggests that access to microcredit programmes has a limited impact on clients’ lives[i]. This is particularly surprising given the substantial evidence that borrowers’ returns to capital in microenterprises are, in general, high[ii]. One of the reasons is the use of classic microcredit contracts – with immediate weekly repayment obligations – offered by microfinance institutions (MFIs) in order to reduce defaults and instil fiscal discipline. These contracts have failed to meet the investment needs of poor borrowers, who have seasonal and irregular income throughout the year. This frequently results in a cashflow disconnect when a repayment is due. Sometimes clients resort to selling productive assets in order to meet repayment deadlines[iii]. Poor borrowers also describe skipping meals or borrowing from informal money lenders at a very high interest rate to avoid defaulting[iv].

The high rates of repayment success trumpeted by the microfinance industry don’t necessarily mean that their customers are doing better, nor does this reflect the struggles clients face while repaying debt obligation through rigid instalments. Often, MFIs resort to coercion and high-pressure tactics, and defaulting on repayments can result in a range of penalties. Borrowers face not just being barred from future loans, but also social sanctions such as humiliation, verbal hostility, harassment, shame and loss of face in their community[v].

One recent study compared rigid weekly repayment schedules – favoured by most lenders – with two alternatives[vi]. The first alternative was a monthly rather than weekly schedule of repayments; the second a flexible plan tailored to each borrowers’ needs. The results were striking.  Both of the alternative approaches dramatically increased the amount that borrowers actually invested in their businesses – by around a third. This is because borrowers did not need to earmark any of their loan for immediate repayment – they could use it all for its intended purpose. Another striking result was that, contrary to conventional wisdom, the alternative approaches did not result in any significant increase in default rate. In addition to these quantitative benefits, the study also reported a reduction in stress for the borrowers, an increase in business optimism and personal satisfaction, and a reduction in the need to seek supplementary loans from informal sources.

Considering this, there is clearly scope for microfinance institutions to build financial products which are better-aligned with the needs of consumers without moving away from their core objective of reducing poverty in a profitable and sustainable manner. Such a model may require MFIs to work more closely with their consumer, to understand their requirements and build customised products depending on the consumer’s cash flows. It is certain that to overcome the barriers which current microfinance models present, there is a need to shun the “one-size-fits-all” approach to rigid microfinance contracts. Flexibility may in some cases reduce payment incentives, and result in a fall in repayments, but there are ways around this problem.  MFIs could take much greater advantage of informal financial channels to collect information on their prospective borrowers (for instance, Ghana Barclays bank works with traditional susu deposit collectors who understand the local economy) or hire local payment collectors to improve the screening of prospective clients, and to monitor repayments (for instance, Safesave in Dhaka hire local women payment collectors, who have a higher rate of success than male debt recovery agents).

Until now, MFIs have largely ignored the demand for flexible financial products: however, increasing competition in the microfinance industry may encourage MFIs to rethink their product design. For MFIs to continue to grow, it is essential that they pay increased attention to their clients’ needs, preferences, behaviours and well-being. In addition, there are clear operational benefits for lenders in adopting less rigid, less frequent repayment schedules. MFIs can certainly lower costs by reducing the frequency of repayments in terms of fewer meetings, fewer collections, and fewer transactions. The reduction in cost could also lower interest rates and enhance their ability to service more clients.

This sensible approach, though, is not easy for most microfinance organisations to implement. Of course, all lenders – whatever sector they serve – seek to encourage prompt and regular repayments from their clients, but the typical MFI (whose borrowers tend to be financially naive and new to borrowing) sees regular repayments as absolutely crucial to success. Some MFIs see it as part of their mission – a duty almost – to instil discipline and prudence in their borrowers. MFIs must also invariably achieve this without the benefit of any in-depth information about each client’s individual circumstances – the kind of local knowledge which is frequently available to informal lenders, who can consequently be flexible in their credit terms. Nevertheless, the benefits are real, and the challenge rests with the microfinance organisations to seek creative ways of transferring these flexibility benefits to the formal sector, by more efficient and effective design of loan contracts.

References

[i] Armendáriz, B. & Morduch, J. 2010,ÌýThe economics of microfinance, MIT Press.

[ii] De Mel, S., McKenzie, D. & Woodruff, C. 2008, “Returns to capital in microenterprises: evidence from a field experiment”,ÌýThe quarterly journal of Economics,Ìývol. 123, no. 4, pp. 1329-1372.

[iii] Khandker, S.R. 2012, “Seasonality of income and poverty in Bangladesh”,ÌýJournal of Development Economics,Ìývol. 97, no. 2, pp. 244-256.

[iv] Jain, S. & Mansuri, G. 2003, “A little at a time: the use of regularly scheduled repayments in microfinance programs”,ÌýJournal of Development Economics,Ìývol. 72, no. 1, pp. 253-279.

Shoji, M. 2010, “Does contingent repayment in microfinance help the poor during natural disasters?”,ÌýThe Journal of Development Studies,Ìývol. 46, no. 2, pp. 191-210

[v] Sett, R.K. 2015, “Should Flexibility Matter? A Poor Consumer’s Perspective of Flexible Micro Loans”,ÌýIIM Kozhikode Society & Management Review,Ìývol. 4, no. 2, pp. 166-169.

[vi] Sangwan, N. 2018, ” Make microfinance great again: does flexibility in repayments affect entrepreneurial behaviour?”

Navjot Sangwan is a PhD student at the University of Durham and Institute of Social Studies, The Hague. Photo:

This blog post is a part of the blog series Inclusive or Exclusive Global Development? Scrutinizing Financial Inclusion,Ìýin which a new perspective on financial inclusion is published every  of February, March and April 2019.