Over the past couple of years, I have had the opportunity of interviewing several small businesses in and around Bangalore. My main interest was to find out how the businesses made money, what their margins were, etc. For some time now, I have been thinking about how small businesses get the finance they need to set up and run their businesses.

Just this week, I came across a reference to a working paper on MSME financing and debt, in an article in ‘The Indian Express’. I decided to also read the original working paper, “Debt traps? Market Vendors and Moneylender Debt in India and the Philippines” published in the National Bureau of Economic Research (NBER) by Prof. Sendhil Mullainathan (Harvard University), Prof. Benjamin N. Roth (Harvard Business School), and Prof. Dean Karlan (Northwestern University).

Let me begin by sharing an extract from the paper on the objective of the study:

“Small-scale entrepreneurs throughout the developing world often rely on moneylenders for working capital, borrowing on a daily or weekly basis at exorbitant interest rates. The ubiquity of this type of borrowing is a long-standing puzzle for development economists: why do these entrepreneurs not save a little bit and then borrow less, given their implicitly high risk-free rate of return to savings? We report on three experiments in which we gave cash grants and brief financial training to market vendors in India and the Philippines with high interest rate debt. We then test how long before, and whether, individuals go back to using high interest rate debt again.”

In order to collect data to analyse and test their hypothesis, the economists designed their experiment in the following manner:

Three experiments were conducted:

  • Chennai, India in 2007 (1000 market vendors)
  • Cagayan de Oro, Philippines in 2007 (250 market vendors)
  • Philippines in 2010 (701 market vendors, from different markets than in 2007)

Treatment arms of the 2007 experiments:

  • Treatment 1: Some entrepreneurs were supported with a Debt Payoff
  • Treatment 2: Some entrepreneurs were given Financial Education
  • Treatment 3: Some entrepreneurs were supported with a Debt Payoff and given Financial Education
  • Control group (none of the above three treatments were given to some entrepreneurs)

Treatment arms of the 2010 experiments (Brief financial education was provided to all the three treatment groups):

  • Treatment 1: Some entrepreneurs were supported with a Debt Payoff
  • Treatment 2: Some entrepreneurs were given a Savings Account
  • Treatment 3: Some entrepreneurs were supported with a Debt Payoff and Savings Account
  • Control group

From here onwards four follow-up surveys were done starting 4-6 weeks after the debt payoff, and ending at the latest two years after the debt payoff. The relevant data was collected during these follow-up sessions.

The observations of the 2007 experiments can be summarized as follows:


First follow up (2-4 months) –

  • Borrowers granted debt relief were only less likely to borrow from a moneylender after the first follow-up, and borrowed only US$8 less on average, relative to a control mean debt of US$25.
  • Financial training had no direct impact on borrowing.
  • The combined treatments of debt payoff and financial training produced results similar to the debt payoff only treatment arm – a reduction in borrowing of US$6.

Second follow up (5-8 months) –

  • Treatment effects had already mostly dissipated for both debt payoff only, and for debt payoff and financial training.

Third follow up (9-10 months) –

  • By the third follow-up, all results were no longer statistically significant for debt payoff only, and for the debt payoff and financial training.


  • Debt Payoff (Treatment Group 1): Borrowers offered debt relief were less likely to borrow from a moneylender at the first follow-up, and by the third follow-up they continued to be less likely to borrow. They borrowed US$47 less at first follow-up and by the third follow-up borrowed US$46 less, relative to a control mean borrowing of US$82.
  • Financial Training (Treatment Group 2): Financial training had no impact on its own.
  • Debt Payoff and Financial Training (Treatment Group 3): The treatment effects for the combined debt payoff and financial training were larger than the debt payoff treatments. Hence there is some suggestive evidence that the financial training in Philippines slowed the reversion rate back into moneylender debt. But, by the final follow-up at 18 months the effect of the combined treatment was almost entirely absent.
  • Result (after final follow-up): At the final measurement, treatment effects for all the three groups had entirely dissipated.

The observations of the 2010 experiment in PHILIPPINES can be summarised as follows:

  • The Philippines 2010 results are more similar to the India 2007 site: borrowers granted debt relief were less likely to borrow from a moneylender after the first follow-up, and borrowed only US$33 less on average, relative to a control mean debt of US$126.
  • The second (4 months), third (8 months) and fourth (18-19 months) follow-ups all show that most of the small businesses returned to the debt-cycle.

From the observations drawn from the above three experiments, an extract of the conclusions drawn by the economists appears clear:

“…most vendors fall back into debt within six weeks, and two years later the likelihood and volume of borrowing at high interest rates is nearly identical for treatment and control vendors. The timing of reversion differs across the experiments. A brief, focused financial education training does little to mitigate this effect. Unsurprisingly, therefore, neither treatment had a sustained meaningful impact on business profits, household expenditures, or ability to smooth against unforeseen shocks.”

Now armed with the conclusion that small businesses re-enter the debt-cycle despite being the debt being paid-off, the authors seek to find the reason behind this phenomenon. Their various arguments are summarized below:

  1. One possibility may be that small business owners may have such high return on investment, that continuous borrowing maximizes long-term profitability. However, this scenario is highly unlikely because in a case otherwise, the enterprises should have witnessed markedly increased profits. However, this is not the case.
  2. Small businesses may be ending up borrowing money simply as a result of lack of proper savings technology. Due to a lack of a place to store capital securely, money may be misspent because of reasons such as family pressure, self-control etc. However, the authors did not find any direct correlation between business profitability and the presence of a formal savings account.
  3. One more case is that maybe small business vendors do not understand the implications of continuous borrowing on long-term costs. However, the financial education imparted to small business owners which was primarily directed towards explaining this concept had little or no effect on the vendors’ overall borrowing.
  4. A final possibility is that small businesses may suffer regular income shocks, and that borrowing reduces the harsh effects of the shocks. Therefore, while the debt payoff in the experiment may have relieved the enterprises temporarily of their loans, subsequent income shocks would have sent back the vendors into the debt cycle.

The results of this study are fascinating. But here are my three questions:

  1. While it is very useful to see the authors trying to understand the reason for vendors getting back into a debt cycle with money lenders, I wonder if a follow up survey asking vendors directly about why they chose to go back to money lenders can give us useful insights.
  2. In order to select the businesses for this study, the authors are likely to have interviewed a lot more of them. I wonder what percentage of businesses interviewed actually had any loans from money lenders.
  3. If savings technology can help small businesses, what can financial sector entrepreneurs do to help?

Lastly, let me end by summarising a big learning for me – I always thought that if small businesses were given financial training, they would hesitate to take loans from money lenders. But since training seems to have almost no impact on borrowing behaviour, at least we should not spend too much money on such training. Is that the right take away?