Abstract:
In this paper, I study how modifications to the standard credit contract affect loan demand and
selection into borrowing, using a random sample of micro enterprises in urban Uganda.
Despite widespread enthusiasm about microfinance as a tool in alleviating poverty, recent
evaluations of microfinance initiatives have found the long run impact on firm growth and the
welfare of borrower-households to be limited. Existing studies of microfinance focus on
present or previous borrowers, and can therefore provide only limited insight into how
effectiveness of micro loans is affected by se-lection into the borrower pool. I study loan
attitudes among a random sample of entrepreneurs, most with no experience of borrowing, in
core sectors within both retail and manufacturing. Hypothetical loan demand questions are
used to test whether firm owners respond to changes in loans' contractual terms and whether
take-up varies by firms' risk type and firm owner characteristics. The results indicate that
contracts with lower interest rates and less stringent collateral requirements are likely to attract
less risky borrowers. This is especially true among manufacturing sectors. The findings
suggest that there is scope for improvement of standard financial contract terms.
