A little at a time: the use of regularly scheduled repayments in microfinance programs

Informal lenders appear to be thriving even in regions where microfinance institutions (MFIs), such as the Grameen Bank, have established lending programs. We suggest that an explanation for this well-documented observation lies in the ubiquitous use of regularly scheduled repayments by MFIs. Borrowers are typically required to repay their loans in tightly structured installments, beginning soon after loan disbursement. This little-remarked aspect of the repayment schedule is usually explained as inculcating 'fiscal discipline' among borrowers. We argue that an alternative rationale for this loan repayment structure lies in the difficulty of monitoring borrowers' actions. The potential for moral hazard leads MFIs to use innovative mechanisms, such as regularly scheduled repayments, which indirectly coopt the better-informed informal lenders. Conversely, this installment repayment structure allows informal lenders to survive. Further, we show that this linkage can not only expand the volume of informal lending, but may also raise the interest rate in the informal sector. (C) 2003 Elsevier B.V All rights reserved.