Flexible Contract, Flexible Morale? Microcredit Design and Repayment Discipline

Recent evidence suggests that more flexible microloan repayment benefits borrowers, but lenders fear diminished repayment morale. We study repayment choices in rigid and flexible loan contracts with discretion in repayment timing. Using a lab-in-the-field experiment with 645 microcredit borrowers in the Philippines, we identify moral hazard and quantify social pressure. Payoff maximization predicts low repayment in our rigid benchmark contract, and increased repayment with flexibility. Results suggest the opposite: Repayment in the rigid contract is high, and drops substantially under flexible repayment. Social pressure decreases. Our results are consistent with a strong social norm for repayment, which is weakened by introducing flexibility. Norms, which may be inculcated by the lender, may help explain several recent puzzles in microfinance research, including high and equal repayment rates across individual and joint-liability contracts, and excessive peer pressure. Importantly, norm-driven behaviour may erode with the introduction of flexibility.