# **1 Introduction**

Debt forbearance policies that allow borrowers to postpone loan payments are a popular tool to soften the impact of economic downturns and have been used to an unprecedented extent in recent crises. More than 80 countries around the world enacted debt moratoria for individuals and firms in response to the Covid-19 crisis.<sup>1</sup> In the United States alone, financial institutions granted more than $2 trillion in debt forbearance to approximately 60 million borrowers over this period (Cherry et al., 2021). However, despite their enormous practical importance, the effects of forbearance policies on borrower expectations and behavior remain poorly understood. On the one hand, repayment deferrals can mitigate financial distress by easing liquidity constraints and strengthening borrowers’ _ability to pay_ (Aydin, 2021; Ganong and Noel, 2020). When repayment flexibility is granted by a private lender, this may also signal an investment in the banking relationship and improve loan repayment through an effect on borrowers’ _willingness to repay_ .<sup>2</sup> This may partly explain why forbearance is common even in markets where it is not mandated.<sup>3</sup> On the other hand, a common concern with repayment deferrals is that they may generate expectations of lenient credit enforcement and future forbearance and give rise to moral hazard through this channel.<sup>4</sup> In this paper, we study the borrower response to debt forbearance using a nationwide field experiment conducted in the context of a large debt moratorium program in India. We take advantage of a collaboration with a leading consumer finance lender, which allows us to issue randomized debt moratorium offers in accordance with India’s forbearance policy for consumer loans in place at the time of the experiment. We first report results from our main experiment which varies whether delinquent borrowers are offered forbearance or not and how forbearance offers are presented to the customer. In the experiment, late-paying borrowers are randomly assigned to receive debt forbearance offers that are truthfully presented either as being _granted voluntarily by a private lender_ or _extended as the result of government regulation_ , or to one of several placebo and control treatments that contain no forbearance offer. We observe the impact of forbearance offers on borrower beliefs as well as the real stakes decisions to repay one’s loan. In a second experiment, we explore the impact of forbearance offers on longer-term banking relationships and demand for future interactions with the lender. To do so, we design a product adoption experiment in which borrowers who received one of the two forbearance offers are contacted with an offer for a personal loan or a non-credit financial product several months after having received a forbearance offer. The treatment conditions vary whether the financial product is clearly marketed as a product of the lender or offered without reference to the name of the lender. In combination, the forbearance and product adoption experiments allow us to

> 1 See World Bank (2022) and International Monetary Fund (2022).

> 2 Forbearance can be interpreted as a flexible contract, which banks can use to intensify relationships with specific borrowers. Bolton et al. (2016) illustrate this point theoretically and provide evidence from lending terms during crises. 3 Cherry et al. (2021), for example, note that forbearance was common in the markets for auto loans and jumbo mortgages, where there was no regulatory requirement to grant repayment deferrals. Forbearance is also common in many markets for consumer finance where it is not mandated. See Supplementary Appendix A for an example from Europe.

> 4 The potential moral hazard costs of forbearance policies are a frequent topic in the news media. See, for example, “Moral hazard! Moratorium extension may trigger more defaults”, The Economic Times, May 22, 2020, on consumer loan forbearance in India or “Biden’s student loan dilemma: America’s two-year experiment in debt deferral has had unintended consequences”. New York Times The Daily podcast, April 18, 2022, on student loans in the U.S.

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