Financiers across the world structure debt contracts to limit the risk of entrepreneurial lending. But debt structures that reduce risk may inhibit enterprise growth, especially among the poor. Using a field experiment we quantify the short- and long-run tradeoffs associated with the classic microfinance debt contract. We contrast the classic contract which requires that repayment begins immediately after loan disbursement with a contract that provides a two-month grace period before repayment begins. The shift to a grace period contract increased short-run business investments and long-run profits, implying average return to capital of over 8% per month. However, we also observe a significant increase in the variance of profits and a tripling of default rates. In this manner, early initiation of repayment reduces risk to financiers but also reduces the potential impact of microfinance on microenterprise growth and household poverty.
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