Give Me a Pass : Flexible Credit for Entrepreneurs in Colombia (English)

Most small firms in developing countries have large month-to-month fluctuations in their income stream due to seasonality and unanticipated positive and negative shocks such as business opportunities, health shocks, etc. While the optimal credit contract with full information would match repayments to cash flows, idiosyncratic and unanticipated shocks are typically hard to verify, and thus full revenue-sharing contracts are typically unavailable. As a result, many microentrepreneurs seeking formal credit in developing countries rely on microcredit loans with fixed, frequent repayments that start immediately after the loan is disbursed. Borrowers may adjust to these rigid terms by holding cash back or by passing on high (risk-adjusted) return investments. Recent attempts to introduce repayment flexibility to existing clients have shown that flexibility can improve business outcomes without deteriorating repayment rates. But this may not be true for first-time borrowers: providing flexibility could backfire if some rigid loans with fixed and frequent repayments are needed to screen or teach discipline in repayment. On the other hand, flexibility could attract new, (in expectation) profitable clients uninterested in the rigid loan. If the share of such entrepreneurs is large, flexibility should be offered to new borrowers. We thus seek to assess the validity of these theories on new borrowers by evaluating experimentally the impact of repayment flexibility on selection, client welfare, and loan performance.