Group lending without joint liability

Abstract

This paper contrasts individual liability lending with and without groups to joint liability lending. We are motivated by an apparent shift away from the use of joint liability by microfinance institutions, combined with recent evidence that a) converting joint liability groups to individual liability groups did not a↵ect repayment rates, and b) an intervention that increased social capital in individual liability borrowing groups led to improved repayment performance. First, we show that individual lending with or without groups may constitute a welfare improvement over joint liability, so long as borrowers have su cient social capital to sustain mutual insurance. Second, we explore how the lender's lower transaction costs in group lending can encourage insurance by reducing the amount borrowers have to pay to bail one another out. Third, we discuss how group meetings might encourage insurance, either by increasing the incentive to invest in social capital, or because the time spent in meetings can facilitate setting up insurance arrangements. Finally, we perform a simple simulation exercise, evaluating quantitatively the welfare impacts of alternative forms of lending and how they relate to social capital.

Social collateral, dynamic incentives, and joint liability in a two‐step trust game: Lending to the unbankable

“…Thus, this paper's primary contribution is to expand previous findings and advance the understanding of MC programs, by building on the existent analysis and providing a theoretical framework of how group dynamics affect individuals' behaviour in a game‐theoretic approach. In this context, this paper fits into the MC literature that highlights social collateral (de Besley and Coate, ; Feigenberg et al, ; de Quidt et al, , ) as a fundamental building block of successful borrower–lender interactions in underdeveloped financial markets. Haldar and Stiglitz () note that both social collateral and trust are the main reasons for MC programs to have succeeded in Bangladesh, and lack of them the main reason for the massive rates of default in India…”

“…Particularly, Varian () looks at how the economic incentive system of Grameen‐like banks affects the repayment rates. Besley and Coate (, p. 3), study borrowers' willingness to pay, and how “ability of group lending to harness social collateral“ affects repayment rates (see also de Quidt et al, , , for extensions on this perspective). Ahlin and Townsend () also provide an excellent empirical study using data from Thailand and find that repayment rates are not always affected positively in MC programs.…”

“…In a series of more recent studies, de Quidt et al (, ) provide evidence that MC programs have been moving to individualised loan and limiting the scope of joint liability. In this context, the role of social capital is a fundamental piece in ensuing that individual lending is welfare improving over group‐lending; social capital allows to sustain mutual insurance.…”

“…MC programs provide an alternative mechanism to channel financial resources to people in the lowest income bracket with no credit history and no collateral. While proponents of MC advocate in favour of this organisational structure; several questions regarding the role of joint liability remain open for debate (see Giné and Karlan, ; de Quidt et al, , , among others). This paper aims at providing some additional answers to the role of social collateral and dynamic incentives as a mean to develop co‐operate interaction among group participants in MC programs by developing a series of game‐theoretic trust games.…”

“…Muhammad Yunus pioneered MC through the creation of the Grameen Bank, and lending under joint‐liability group settings. More recently, de Quidt et al () note that under the new Grameen II model, individual liability lending is becoming more popular. Under the MC approach, nongovernmental organisations lend money without the need of collateral.…”