We develop a simple model that outlines how households might adjust their borrowing and investment behaviour when offered the new labelled loan. The model explicitly incorporates the lower interest rate and also allows the label to influence households’ borrowing and investment choices. A key insight that emerges from the model is that when households are sensitive to labels, the label will induce them to make the investment associated with the new loan, and more so than when the loan is not labelled. As a result, introducing the sanitation loan will motivate sanitation investments. The lower interest rate, and additional supply of credit will also increase sanitation investments. Interestingly, the model also indicates that not all sanitation loans will result in sanitation investments if there are households that are not sensitive to the label. The lower interest rate will induce households to substitute away from more expensive credit sources without altering its investment choices. Thus, sanitation loan demand on its own is not necessarily informative of sanitation investments.

Insights from the model also provide a direct test for the loan label in influencing households’ choices. The test relies on the fact that if households are insensitive to loan labels, they would respond to the lower interest rate on the sanitation loan, and substitute away from more expensive loans, regardless of their investment behaviour. By contrast, households that are sensitive to loan labels will not substitute away from the business loan in a similar manner.<sup>2</sup> Rural India is a particularly apt context in which to study the adoption of household toilets. According to the WHO-UNICEF Joint Monitoring Program, around 57 percent of households in rural India practiced open defecation in 2015.<sup>3</sup> Lack of access to safe sanitation is even more pronounced in our study context – Latur and Nanded districts in Maharashtra. Only around 27 precent of study households had a private household toilet before the roll-out of the sanitation loan program.<sup>4</sup> Interestingly, households in this context typically identify the financial cost and affordability as the key reason for not having a toilet: 83 percent of households that do no own a toilet report that they are not able to afford one (Augsburg et al., 2015); making the sanitation loan program particularly policy relevant.

Our empirical findings indicate that, in this context, households demand the newly available loan product: two and a half years after the rollout of the new loan, 18 percent of clients have taken the loan. However, this is not a surprising finding given the lower interest rate, weak monitoring and no enforcement. Households might avail the loan to make other desired investments beyond sanitation, or for consumption purposes. They might also avail the loan to substitute for other - less favourable - credit sources. Moreover, examining data on other loans taken from the MFI, we find little evidence of substitution away from the more expensive business loan to the cheaper sanitation loan: 62 percent of clients who were eligible for a sanitation loan took a (more expensive) business loan instead. We also find no evidence that clients take more expensive business loans only after exhausting the cheaper sanitation loan: 31 percent of clients, who could have taken this combination of loans thereby reducing overall borrowing costs, chose to take a more expensive business loan only. This evidence thus indicates

> 2Unfortunately, the model does not yield insights that would allow us to separate out the effects of credit constraints or the lower interest rate based on average impacts. However, focusing on specific subgroups, e.g. those who are not credit constrained, would allow us to separately identify the relevance of these.

> 3Source: UNICEF-WHO JMP, www.washdata.org. Last accessed June 2018.

> 4Community toilets are rarely available in the study area; and it is very uncommon to share neighbours toilets in rural India.

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