Defining Social Collateral in Microfinance Group Lending

Abstract

Microfinance group lending with joint liability allows asset-poor individuals to replace physical collateral by social collateral. The literature on microfinance lacks a rigid framework for analyzing the consequences of using social collateral for borrowing behavior and repayment. This paper fills the gap by providing a theoretical framework to evaluate the impact of social collateral pledged by group borrowers on group lending repayment. Our approach is novel as we take into account the external ties of group borrowers, i.e. the social ties linking borrowers to non-borrowers from their community, whereas previous work in this field has looked solely at internal ties (i.e. between group members). One of the important features of our model is that we stress the impact of network configuration on the amount of social collateral pledged. Our model shows why the group lending methodology works better in rural areas than in urban areas, namely because rural social networks are typically denser than urban ones, which results in higher social collateral. AbstractMicrofinance group lending with joint liability allows asset-poor individuals to replace physical collateral by social collateral. The literature on microfinance lacks a rigid framework for analyzing the consequences of using social collateral for borrowing behavior and repayment. This paper fills the gap by providing a theoretical framework to evaluate the impact of social collateral pledged by group borrowers on group lending repayment. Our approach is novel as we take into account the external ties of group borrowers, i.e. the social ties linking borrowers to non-borrowers from their community, whereas previous work in this field has looked solely at internal ties (i.e. between group members). One of the important features of our model is that we stress the impact of network configuration on the amount of social collateral pledged. Our model shows why the group lending methodology works better in rural areas than in urban areas, namely because rural social networks are typically denser than urban ones, which results in higher social collateral.

Constraints to formal small business performance in the service sector in Cameroon

“…(2012) argue that trust can encourage business partners to explore the advantages of cooperation. The resulting reciprocity promotes a high trust environment conducive to accumulating more reliable soft information and better risk hedging (Postelnicu et al ., 2014). As a result, the problems associated with moral hazards can be minimised.…”

“…Moreover, members are likely to behave in a way that preserves their social capital because defaulting can result in significant sanctions such as loss of networks and reputation. The self-reinforcing nature of networks means that these adverse effects can be transmitted through networks and hurt present prospects of accessing finance and future borrowing (Postelnicu et al. , 2014).…”

Institutions and social capital in group lending

“…As argued in the Introduction, since group lending is a collective undertaking, the capacity for collective action, known as social capital, should be relevant for the success of this MFI instrument. Indeed, the concept of social capital, variously defined and interpreted, features prominently in the microfinance and group lending literature (see, e.g., surveys in Postelnicu et al, 2014;Marconatto et al, 2016; for a general discussion of the role of social capital in group lending see Haldar and Stiglitz, 2016). Various empirical studies provide massive evidence that social connectedness, strength of peer pressure and grassroots sanctions, likelihood of opportunistic behavior and other measures and/or correlates of social capital are essential parts of "social collateral" and hence have significant effect on group lending.…”

“…One could expect that bonding social capital should have more immediate bearing on group lending, which requires collective action within small teams, and this is indeed what Cassar et al (2007) demonstrate in an experimental setting, where personal trust between participants in microfinance game was found to be more important for group loan repayment than general trust in the society. However, Postelnicu et al (2014) stress the importance of external social ties of group borrowers (in the spirit of the "strength of weak ties" concept, due to Granovetter, 1973), as they increase the weight of social collateral by entailing broader and hence heavier social sanctions against dishonest or opportunistic behavior. This observation is consistent with greater success of group lending in rural areas, where social networks are usually denser than in cities and towns.…”

“…First, obtaining and repaying a group loan is a quintessential collective action, and as such, it should be rooted in social capital, which embodies social collateral (similarly to physical capital pledged as a conventional tangible collateral in individual lending). Indeed, mutual trust, shared values, social networks, peer monitoring and other ingredients of social capital are all prominent features and prerequisites of collective lending (Postelnicu et al, 2014;Marconatto et al, 2016;Haldar and Stiglitz, 2016). Second, despite the common perception of group lending as a largely informal financial instrument, owing its popularity to a failure of formal institutions to supply property titles over assets that households and businesses own de facto (De Soto, 2003), institutions maintain a substantial role in group lending, which involves loan agreements subject to third-party enforcement, credit score systems, etc.…”