Gradual Repayment with Sequential Financing in Microfinance

This paper examines two dynamic features associated with microfinance schemes, namely gradual repayment and sequential financing.

Group lending has helped resolve some of the underlying problems associated with lending to the poor, in particular the lack of information about borrowers and their inadequate collateral. Grameen Bank’s success and its high rates of repayment have led to interest in examining whether innovative MFI institutional features play a role in their success.

Many MFIs adopt gradual repayment and sequential financing as institutional designs. The paper explains these features through the concept of dynamic incentives, especially the idea that the incentive to default should be relatively uniformly distributed across time. It formalizes this intuition in a model that allows project returns to accrue over time rather than at a single point. It demonstrates that:

• Schemes with gradual repayment can improve efficiency when compared to those that do not;
• Sequential lending can help improve project efficiency and may implement efficient outcomes;
• Repayment incentives are lower in the case of social capital;
• Maximum feasible project size is smaller with side payment.