Time Preferences and Flexible Debt Utilization
Borrowers with high discount rates (impatience or present-bias) struggle to execute multi-period capital investment plans when provided with liquidity early in the loan cycle, reducing the long-run business impact of flexible debt contracts.
Picture this
If a hungry farmer receives a cash loan with no immediate monthly payment deadline, they face strong temptation to spend the money on immediate food and household needs rather than buying seeds that take months to harvest. Immediate repayment rules act like forced discipline that prevents short-term consumption of loan capital.
What the evidence says
Impatient clients assigned to a grace period generated Rs 1,193.6 lower monthly profits relative to patient clients (p < 0.10), demonstrating that high baseline discount rates attenuate grace period benefits.
- Who
- 721 female microfinance clients tested using a 1-month delayed lottery choice game in Kolkata, India.
- How
- Subgroup treatment interaction comparing clients with above-median discount rates (mean baseline discount rate of 18.9%) against patient clients.
What to do
Assess borrower discount rates alongside business plans when deploying flexible debt to ensure capital is allocated toward illiquid production rather than immediate consumption.
From the source
"Similarly, grace period contracts may be poorly utilized by present-biased clients (Fischer and Ghatak 2010)."
101_290 microfinance and entrepreneurship AER2013.pdf