Microcredit Product: An Action Research on Fixed vs. Flexible Repayment Schedules
By Jayesh Jain | Jayesh was a research associate at CMF. He joined KAS Foundation in 2006.

Are MFIs too rigid with repayment schedules on loans? Loan-defaults have been noticed time and again in borrowers engaged in seasonal enterprises. Many do not deliberately renege on payments; they are unable to pay back during the lean period, and often dip into their savings and consumption expenditure. Some even find themselves resorting to informal creditors. Can MFIs then allow more flexibility? KAS, an MFI that operates in the states of Orissa and Chattishgarh, faced problems of repayment from its clients engaged in dairy-related enterprises, especially in Orissa, where dairy is a primary livelihood option second only to agriculture. Cattle do not yield milk when they are calving, so how do clients pay back in the lean period without dipping into their savings? KAS Foundation's clients also have a range of livelihood options comprising of usual activities of agriculture, dairy, micro-enterprise, and short-term business which allow them to exploit time utility (purchasing at lower prices and selling at higher prices later), form utility (engaging in peeling or other forms of non-timber forest products), and place utility (purchasing at one place with surplus and selling at places with scarcity at higher prices). The capital required for these short-term activities is very low (from $4—$40) and the return can be as high as 100% within a three-month time-frame. Therefore, it is possible that if KAS exempts clients from monthly repayment obligation during that time, clients might be able to undertake some of these income generating activities; KAS Foundation's recovery performance will not be impaired. Bearing in mind the lean season challenge and the income generating opportunity, KAS Foundation, in collaboration with Prof. Sendhil Mullainathan (Harvard University) and Centre for Micro Finance, Chennai, has started a two-year action research project to study the impact of specially designed repayment schedules for dairy clients organized in self-help groups (SHGs). Because of the varied socio-economic conditions of clients even at the group level, it makes more sense to tailor repayment schedules to individuals rather than groups. How then could group solidarity be preserved? The challenge lay in allowing individual flexibility yet maintaining common features and rules for everyone in the group. To help design the dairy loan products, CMF conducted one month of focus-group discussion market research among KAS Foundation's dairy clients. Based on the findings, two products were recommended. Both products are INR 6,000 ($133) loans of 24 months loan tenure at 10.75% annual flat interest rate. The first product, Dairy Research Advance Payment (DRAP), is implemented among 50 groups. Clients need to repay two principal installment and one interest installment in the first six months. After six months, as clients have already prepaid six additional principal installments, they have the opportunity to skip any six principal installments in the remaining loan tenure. While designing this product, there is no attempt to link loan use with repayment liability. Assumptions are that (i) repayment will come from "household income" not from "asset purchased with loan" alone and (ii) clients should have enough disposable income in the first six months; since the lactation period for most cattle lasts for six to nine months after purchase, clients will surely have enough disposable income from dairy and other household income. The second product, Dairy Research Coupon Based (DRCB), is also implemented among 50 groups. At the time of disbursement, clients are provided with a booklet containing 24 monthly principal installment coupons and 24 monthly interest installment coupons. In first three months, clients need to make mandatory monthly principal and interest payments. After this, clients make mandatory monthly interest payments, but the client can lag behind two principal installment obligations. This lagging behind can take following forms:

1. Two consecutively skipped principal installments
2. Two consecutively skipped principal installments, then in the subsequent third month, repayment of one additional principal installment along with the obligatory principal installment for that month. The client will lag behind by only one principal installment while maintaining regular payments for the coming month. In this case, the client again can skip one more installment in following months. The client will then be lagging behind by two principal installments.
3. One skipped principal installment in any month, followed by regular repayment; clients still need to compensate for this missed installment. Even with one skipped principal installment, the client can skip one more installment as long as they do not lag behind by more than two principal installments.

If clients make up their skipped principal installments, they can again avail the option of skipping principal installments as mentioned above. The client cannot prepay more than two principal installments. This product allows for flexibility at the individual level while remaining easy to administer; in this method of skipping or prepaying principal installments, the client and the loan officer need to only be observant that (1) one compulsory interested payment is made every month; interest cannot be prepaid or skipped, and (2) at any point after the third month, the difference between the number of months remaining in the loan tenure entry in the principal coupon book and the interest coupon book should not be more than +/- 2 months. DRAP works like a debit card—the flexibility option depends on the performance of the clients in the previous six months. DRCB, on the other hand, works like a credit card—the flexibility option can be availed first, and then the skipped principal installments can be made up. The performance of these two products will be analyzed against the KAS routine product (Rs. 4,000 ($ 67), 24 months loan tenure @ 10.75% flat per annum interest rate with fixed repayment schedule of principal plus interest per month) and the same KAS routine product but with higher a principal amount of Rs. 6,000 to isolate the effect of the higher principal. Selection of both the control and treatment groups will be randomized. A baseline household survey will be done to measure the existing conditions, followed by short quarterly surveys designed to track income flows and identify any patterns or logic in skipped principal payments. Larger surveys will be conducted after one year and at the end of the loan tenure. It can be assumed that products in sync with the client's economic profile will increase product uptake, promote better utilization of the loan, and presumably reduce willful default due to better investment planning by clients. However, movement towards a more flexible schedule could strain the organizational capabilities of the MFI and might lead to increased transactions cost or higher levels of operational risk. CMF will analyze the impact of the two proposed loan products based on KAS Foundation's recovery performance to see the impact of this change in repayment schedule from operational, financial and risk perspective. Findings of this research project will be available by the end of 2008.