Debt Restructuring in the Shadow of Moral Hazard: A Field Experiment with Small Businesses

The experiment focuses on a set of small firms (“borrowers”) that have borrowed from the lender and are currently in arrears. The small firms in our setting are minibus taxi owners who borrow from the lender using a debt contract, with the loan secured by the minibus. These business owners generate revenue by driving the minibus and are responsible for making fixed monthly payments, determined at loan origination, to the lender. The company decided to run the experiment on 3,186 borrowers who were delinquent at the time of the experiment.

We worked with the lender to randomize with stratification on eight groups. These eight groups are created by dividing the sample at the median across three variables: (a) the size of the effective payment reduction (%) the firm would receive if in the payment reduction group; (b) the size of the effective principal reduction (%) the firm would receive if in the principal reduction group; (c) the debt to income ratio. Our randomization aims to obtain three equally split samples across the control and two treatment conditions.

The lender will manage the communication with the customers. The experiment is structured in a way that customers are automatically enrolled in the new program, but they are allowed to opt out of this option at no cost. Customers will first receive the communication about their enrollment into the offer via an SMS. The message will contain a link to the letter detailing the new contractual terms. If the borrower decides to not take-up the offer, then she needs to opt-out within five business days. The company will follow up with phone calls in case the SMS is undeliverable. After the opt-out period, the lender will connect with borrowers explaining to them the terms of their new contract using follow-up phone calls.

2023-11-13

2024-03-31

Loan performance: First, we plan to examine outcomes that capture the repayment activity by borrowers. This includes (i) how much borrowers pay month by month; (ii) the number of missed installments; (iii) NPV of the cash flow in the one year after the experiment; (iv) measures of delinquencies and default, month over month and over the one year; (v) a summary index of above measures.

Labor Supply Outcomes: Second, we plan to examine the outcomes of firm’s labor supply measure during the intervention period. For instance, using the lender’s proprietary data on borrowers’ driving, we can observe the number of trips that the firm has conducted per period, the total length of the trip, the distance driven. We will also be looking at the number of times firms were involved in an accident, obtained through data on their insurance claims, and of over-speeding.

Repayment and borrowings from other debt sources: We will analyze spillovers on other forms of borrowings reported in the credit bureau data. This includes any adverse flag, amount of debt overdue, late payments, new account openings, the share of borrowings overdue, total borrowings, borrowings by different sources, and defaults on those debts.

Each borrower is randomly assigned to one of three experiment arms. Every borrower, including the ones in the control arm, receives a loan transformation. Borrowers in the control arm are then used as a benchmark to assess the size of the payment and principal reduction. The three offers received are the following:

(1) Control group: firms in the control group are presented with a new loan, featuring the same principal amount as their original outstanding loan, and with a monthly payment resembling that of the initial loan. Accepting this offer can still be advantageous for borrowers, as it helps them avoid accumulating late fees (in the form of interest on unpaid interest) from their delinquent loan. This method serves the purpose of bringing all borrowers in the sample to a "good standing" and also facilitates a more straightforward evaluation of the benefits associated with each of the other intervention methods. The modification allows the borrowers to avoid a negative flag on their credit report.

(2) Principal write-off group: the restructured loan for firms in this treatment arm has the same monthly payment as their original loan. However, these borrowers receive on average a 17% reduction in the total size of the loan they owe to the lender at the time of the experiment. As a result, the new maturity of the restructured loan is lower than the control group.

(3) Payment reduction group: the restructured loan for firms in this treatment arm matches the total amount paid in the control group. However, these firms receive on average a 13% reduction in monthly payments. This reduction allows borrowers to effectively extend the maturity of their loan, accommodating the smaller monthly payments.

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Randomization done in office by a computer

The unit of randomization is the loan account (borrower of the minibus taxi). The firms will be randomized into one of the three groups, i.e., principal write-off, payment reduction, and the control group.

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3,186 borrowers

1,061 borrowers (payment reduction treatment); 1,062 borrowers (principal write-off treatment); 1,063 borrowers (control)