On the Viability of Group Lending when Microfinance Meets the Market

Abstract

Besley and Coate (1995) analyse the impact of joint liability and social sanctions on repayment rates when repayment enforcement is imperfect. Motivated by the microfinance industry’s move towards markets, we conduct an equilibrium analysis of the Besley–Coate model. We find that individual loan contracts may be used in market equilibrium, even though group lending entails the higher repayment rate and the lower break-even interest rate. This is because group lending causes potentially large deadweight losses. The market equilibrium is possibly characterised by financial fragility, redlining or rationing. Cooperation between borrowers and social sanctions imposed on each other in the case of strategic default turn group lending into the equilibrium mode of finance and ameliorate the market failures. JEL Classification: G21

The Role of Group Size and Correlated Project Outcomes in Group Lending

“…I explore the interaction between group size and correlated project realizations in the setting of strategic default, in contrast to earlier theoretical literature (e.g., [11] [12] [13] [14]). This paper contributes to the literature on group size in micro lending in two ways, namely the structure and performance of optimal group credit contracts group size and the degree of correlated risk varies this document seeks to generalize along both group-size and correlated risk dimensions in the strategic default context.…”