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Conceived and designed the experiments: EF RP JP. Performed the experiments: EF RP JP. Analyzed the data: EF RP JP YP. Contributed reagents/materials/analysis tools: EF TP JP YP. Wrote the paper: EF RP JP YP.
Financial stress is widely believed to cause health problems. However, policies seeking to relieve financial stress by limiting debt levels of poor households may directly worsen their economic well-being. We evaluate an alternative policy – increasing the repayment flexibility of debt contracts. A field experiment randomly assigned microfinance clients to a monthly or a traditional weekly installment schedule (N=200). We used cell phones to gather survey data on income, expenditure, and financial stress every 48 hours over seven weeks. Clients repaying monthly were 51 percent less likely to report feeling “worried, tense, or anxious” about repaying, were 54 percent more likely to report feeling confident about repaying, and reported spending less time thinking about their loan compared to weekly clients. Monthly clients also reported higher business investment and income, suggesting that the flexibility encouraged them to invest their loans more profitably, which ultimately reduced financial stress.
The success of microfinance – the system that aids poor women in developing countries by offering them small collateral-free loans – was acknowledged internationally in 2006 when Muhammad Yunus and the Grameen Bank won the Nobel Peace Prize , . While the microfinance model has increased economic opportunities for the poor, its strict repayment requirement has come under fire in the media after reports of suicides among loan defaulters in the Indian state of Andhra Pradesh in 2010 . A central concern is that the psychological burden of frequent repayment – particularly among poor clients who often lack the financial tools to optimally manage loans – may in many instances offset the positive influence of access to credit, making microfinance borrowers worse off in terms of mental well-being .
The typical microfinance borrower faces a very rigid repayment schedule that requires her to make installments on a weekly basis beginning shortly after loan disbursement. While such a contract is believed to be an important component of keeping default at bay , frequent repayment also limits clients' ability to deal with short-term shocks to household income and could, therefore, be an important source of anxiety when there is a high degree of income variance. Our study rigorously examines whether a small adjustment in loan structure that reduces repayment rigidity can make it possible for clients to experience the economic benefits of microfinance with minimized financial stress.
Financial stress is well documented in the psychology literature to be an important factor leading to mental health problems –, which in turn are among the most important causes of morbidity in the world, and which produce considerable disability in developing countries –. Indicators of poverty and risk for mental disorders are highly correlated in the developing world . Hence, minimizing financial stress is of first-order importance.
Yet, despite the media's portrayal, rigorous evidence that microfinance indebtedness negatively impacts mental health is lacking . Moreover, theory suggests that the regulations which have been proposed to curb microfinance clients' stress levels have ambiguous implications. Nevertheless, largely based on case-study evidence, the Indian federal and state governments have moved to increase regulation of the microfinance sector .
Here, we provide experimental evidence on a key product design feature – repayment frequency. Poor households' income is often irregular and uncertain . As a result, frequent repayment requirements could be a source of stress. Yet, one can imagine less frequent repayment increasing financial stress if clients procrastinate in preparing and have to scramble to make a larger installment at the end of each month.
Observational evidence is unable to identify the causal impact of repayment flexibility on stress in large part because there is little variation in repayment schedules across microfinance clients, and because, where alternative payment plans are possible, clients who face differentially stressful economic lives are likely to select into the repayment schedule that best suits their needs. , for example, shows that microfinance clients who select into more flexible repayment schedules repay more of their loan. However, these results could be driven by either selection or a change in behavior due to the loan contracts. Here, we use a randomized experiment to provide causal evidence that more flexible repayment reduces client stress. Although we are unable to pinpoint the channel, the time trends in stress and income suggest that an important channel is likely to be the fact that flexible repayment schedules allow clients to invest in more profitable assets.
Our findings complement a growing experimental literature on the impact of microfinance. These studies report limited to no effects of the classic microfinance contract on average poverty rates among microfinance clients, despite significant benefits for some population subgroups –. Our study suggests that one reason for this may be that client investment behavior (and subsequent income) is sensitive to the design of microfinance debt contracts. In other words, if well designed, microfinance products have the potential to provide poor entrepreneurs with valuable credit that ultimately reduces their financial insecurity and related levels of stress, improving their economic and mental well-being.
Any study that compares outcomes across microfinance clients who self-select into either the traditional weekly repayment schedule or the more flexible monthly repayment schedule potentially obfuscates the true impact of less frequent repayment on financial stress, since different types of clients are likely to sort into each repayment schedule. Our study addresses this concern by using a randomized controlled trial (RCT) experimental design. Harvard's Institutional Review Board approved the study design and protocol. Verbal informed consent was obtained from all participants (due to low education level among respondents, written consent requirement was waived).
We partnered with a large microfinance organization called Village Financial Society (VFS) in Kolkata, India. At the time of the study, VFS loans were distributed through five-member microfinance groups. Each client received an individual loan and her ability to obtain a subsequent loan depended only on her personal repayment record (individual liability as opposed to joint liability group lending). The loan was uncollateralized and the modal value was US $222 excluding interest costs, which were ten percent of the loan size. Clients were required to make periodic repayments to the loan officer beginning shortly after loan disbursal in a group meeting conducted in their neighborhoods.
In total, 213 clients participated in this study, all of whom were selected from a larger study group of 740 clients. Between January and September 2008, VFS recruited clients and formed 148 five-member groups comprising 740 clients. Loan sizes varied from Rs. 4000 to 12,000 (~$90 to $260), with a modal loan size of Rs. 10,000. Randomization was implemented using a random sequence of numbers generated with statistical software by the project research assistant. Treatment status was assigned to batches of 20 groups at a time based on the timing of group formation with a 11 allocation ratio.
After group formation and prior to loan disbursement, the field coordinator called the project research assistant to determine whether a group had been randomly assigned to either a five-weekly repayment schedule (from here on referred to as “monthly”) or a weekly repayment schedule. One exception is the first batch of treatment groups, which was composed of 12 groups assigned to a four-weekly repayment schedule as opposed to a five-weekly repayment schedule. The change to a five-weekly repayment schedule was made to better accommodate VFS' logistical needs. Clients on the four-weekly experiment were not selected for the study considered here. More information on client selection and randomization is available online in Text S3. Clients were informed that repayment would be determined by lottery. Since all members of a group were restricted to have the same repayment schedule, the trial was a parallel cluster-randomized trial.
From these 740 clients, we randomly invited 105 weekly and 105 monthly clients to participate in the Daily Consumption Survey (DCS). Selection was based on a random sequence of numbers generated with statistical software by the project research assistant. Due to a major festival scheduled to occur several weeks after the start of the DCS survey, we chose the monthly clients from the 21 monthly groups with starting dates that ensured that the DCS survey could run from one repayment to the next for monthly clients without interruption by major festivals. To ensure balance across treatment arms, we selected the weekly clients from the 74 weekly groups with group formation dates that overlapped with the 21 monthly groups.
Twenty-three of the 210 initial clients dropped out, including 11 from control and 12 from treatment. Although the attrition rates were similar for both groups, it is possible that the types of clients that dropped out of the treatment group were systematically different from those who dropped out of the control group. For this selection to generate the main results we present later, clients who dropped out of the control group would have to have significantly lower average baseline stress levels than clients dropping out of the treatment group, which is not supported by a comparison of baseline stress measures across attritors in both groups.
To maintain a target sample size of 200, we randomly selected an additional six weekly and seven monthly clients from the larger study group of 740. The sample size of 200 was chosen based on budget considerations. To summarize, a total of 111 weekly clients from 45 groups were randomly assigned and received the intended treatment, while 100 clients from 42 groups were analyzed for the primary outcomes. A total of 112 monthly clients from 26 groups were randomly assigned and received the intended treatment, while 100 clients from 26 groups were analyzed for the primary outcomes. In the next section, we discuss how we compute standard errors in light of the potential correlation of outcomes within loan groups.
On average, weekly clients paid US$5.40 every week, while monthly clients paid $27.10 every five weeks. The loan duration in both cases was 45 weeks.
In order to assess financial stress levels accurately and in real time, we employed an innovative application of cell phone technology to survey clients every 48 hours for seven weeks. Clients were surveyed on average 16.5 weeks after receiving the loan. By contacting the microfinance clients in our study via cell phones, which were provided to each client for the purpose of this study, we mitigated recall bias, reduced non-response and non-participation rates, and collected 5000 surveys (200 clients surveyed 25 times each) in a cost-effective manner. In order to truly understand consumption smoothing and liquidity constraints among the poor, one needs data that accurately measures consumption levels, income, and assets of households over time. Particularly for consumption data, several potential sources of reporting error have been documented in the economics literature, the most important of which are recall mistakes, inability to capture total household consumption, and level of aggregation of consumption categories , . In our project, we have attempted to mitigate the risks posed by each while keeping logistical demands and costs of surveying reasonably low through a novel survey implementation strategy that leverages cell phone technology available in our study region. For more details on reporting error on consumption data, see .
Each time the survey was administered, we measured clients' level of financial stress with four questions: confidence in ability to repay loan, anxiety about loan repayment, argument with spouse about finances, and time spent thinking about repayment. We construct four indicator variables to capture financial stress: 1 if they did not feel confident about their ability to repay the loan; 1 if they felt worried, tense, or anxious about paying the next loan installment; 1 if they argued with their spouse in the last 24 hours; and 1 if they spent at least five minutes thinking about repayment during the past day. The Cronbach Alpha for these measures is high, at 0.8386, suggesting that it is appropriate to think of the different questions as measuring one underlying construct. Thus, in addition to the individual variables, we report the effect of the equally weighted average across the four outcomes. We call this construct the Financial Stress Index.
Self-reported financial stress is an important measure of household well-being. Indeed, in our sample, financial stress is positively correlated with observable indicators of poverty, although not at a statistically significant level. The average value of the Financial Stress Index is higher for clients who are illiterate, report not having a savings account, had a shock within the past 30 days, do not have a household business, and are in the lower half of the asset distribution.
Evidence on the health relevance of self-reported measures of stress comes from a large literature that documents significant correlation between stress biomarkers (which bear a direct relationship with human health) and self-reported measures . conduct a literature review of studies documenting a correlation between blood pressure levels and self-reported measures of job strain. More similarly to the stress measure used here , find that responses to questions about ability to meet financial obligations, such as food, clothing and medical care, correlate with measures of blood pressure and cortisol response. Similarly , find herpes antibody levels and self-reported measures of stress are correlated in a sample of low-income women. However, the same study does not find an association between measures of salivary cortisol response and self-reported stress measures. The absence of a significant correlation between cortisol response and self-reported stress measures appears to hold more generally . conducts a literature review of the correlation between salivary cortisol and self-reported mental stress measures and conclude, “the evaluation of the studies in this paper showed insufficient evidence for an association between self-reported mental stress and the cortisol response in field studies.” The authors also detail some of the difficulties in collecting saliva swabs in a reliable way for cortisol testing.
Because the contracts were randomly assigned to clients, a comparison between treatment arms has a causal interpretation. Ordinary Least Squares (OLS) regression analysis allows us to compare monthly and weekly clients controlling for variables such as day of the week, whether the survey took place in the morning, and cohort effects.
For all outcome variables we estimate simple ordinary least squares regressions of the following form: where ydig is the outcome of interest for client i in group g on day d and Tg is an indicator variable that equals one if the group was assigned to the five-week repayment schedule. All regressions include dummies for stratification batch (Bg), day of the week (Pdig), whether the survey was taken in the morning (Mdig), number of weeks since disbursement (Wdig), and the calendar week (Cdig). The vector Xig, which is present only in the specification labeled as including controls, consists of age, marital status, household size, Muslim, literate, has savings, negative shock in last month, has household business, total asset value, and loan size. Regressions including Xig also control for loan officer fixed effects. In all regressions, standard errors are corrected for clustering within loan groups using Huber-White standard errors.
Before turning to the results, we discuss our primary hypotheses regarding the possible channels of influence. Increased flexibility in repayment can influence mental stress among clients through several channels:
We expect that these channels of influence will interact. For instance, less frequent repayment can increase client income while at the same time increasing default through its impact on fiscal discipline. Hence, the net effect of less frequent repayment on mental stress remains an empirical question.
Figure 1 shows that monthly clients scored 45 percent lower on the Financial Stress Index than weekly clients (P<0·05, t test). Monthly clients report being worried about repayment 51 percent less often than weekly clients (P<0·05, t test), and report a lack of confidence in their ability to repay their loan at a rate that is 54 percent lower than weekly clients (P<0·05, t test). Monthly clients are also 60 percent less likely to spend significant time thinking about loan repayment (P<0·05, t test).
The results show that flexibility in repayment reduced clients' mental stress along several dimensions, suggesting that product design can play a key role in influencing how microcredit affects the financial stress of the poor.
Our survey provides suggestive evidence on the channels of influence associated with less frequent repayment:
Presented with the problems caused by financial stress, policymakers often believe the right response to is to reduce overall financial indebtedness. But there are many reasons to believe that access to credit is critical to improving economic outcomes for the poor in developing countries. In this study we consider self-reported measures, which allow us to ask specifically about the stress that arises from managing money or finding the means to pay for the next loan installment. Our results show that, holding availability of credit constant, changing the terms of the contract can significantly alter these stress measures. In particular, increasing repayment flexibility greatly reduces the mental health burden of indebtedness.
We find little evidence that the less frequent payments affected social interactions, default, spending on temptation goods, or clients' ability to smooth income.
Rather, our results suggest that a schedule requiring less frequent payments leads to a reduction in financial stress because it enables clients to use their credit more wisely and take advantage of profitable investment opportunities, which results in higher household income.
Weekly vs. 5-weekly Randomization Check.
Coefficient of Variation.
Description of Village Financial Society.
This study was funded by the ICICI Foundation, Exxon-Mobil, International Growth Center, and the U.S. Department of Labor. These sources did not play a role in the data collection, analysis, interpretation, trial design, recruitment or any other aspect pertinent to the study. The funders had no role in study design, data collection and analysis, decision to publish, or preparation of the manuscript.