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									Group Lending Microfinance
• In the last class we argued poor borrowers can access loans in

• In the case of ROSCAs individuals access credit from other group

• In the case of Credit Cooperatives, individuals can access credit
  from group members and from “outside” sources

• But mobilizing savings under both scenarios has limitations

• How about extending credit from outside sources (i.e., donors,
  commercial banks) to groups of individuals without collateral? ←
  today’s class

   1) Incentives to put effort and monitor under group-lending

   2) The role of social sanctions
1) Incentives to put effort and monitor

    Some history first:

    The group – lending microfinance technology often attributed to
    Muhammad Yunus (Nobel Peace Prize 2007)

    Yunus launched a microlending project ( the Grameen Bank) in
    Bangladesh in 1976

•   The technology has evolved considerably over the past years

•   Meanwhile, a large number of articles have been written to shed
    light on Yunus’ financial innovation

•   Such articles borrow from the literature on asymmetric information
    → capital market imperfections (previous classes)
   Main intuition:

• In group-lending microfinance participant borrowers organize
  themselves into groups

• Each participant borrower responsible for the debt of others. If the
  entire group's debt is not repaid, all group participants are excluded
  from future refinancing: “joint responsibility default clause”

• The “joint responsibility default clause" induces peer monitoring
  because a borrower that defaults creates a negative externality on
  others, namely, others have to pay for his/her share of the debt, or,
  else other borrowers cannot access future loans from the MFI

• Incidence of default is reduced because participants make sure that
  their peers put adequate effort

• Relative to the donors or commercial banks, monitoring is less costly
  for the borrowers (i.e., can monitor each other more easily because
  of geographical proximity)

• Delegating monitoring activity increases repayment rates and makes
  credit from commercial sources or donors feasible→ efficiency gains
More formally:

Assume first that effort linked to success, and that investment requires $1

A borrower that puts effort and invests $1  y with prob. 1

a borrower that does not put any effort and invests $1  y only with probability p < 1.
She obtains “0” with complementary probability 1 – p

Let us see the R for an individual borrower to be indifferent between putting effort and
not putting effort
                                   y  R  c  p( y  R)
                                     
                                           
                                     effort      no effort


                                     RI  y 
                                                1 p

If the lender needed a higher R in order to break even, incentives will be undermined:
the lender anticipates no effort  high probability of default  NO LENDING!! And
this is bad for efficiency
Now suppose that the bank refuses to even consider extending a loan contract
unless the borrowers come to the bank in groups of two ( for simplicity)

And suppose the bank imposes the “joint responsibility default” clause

And let’s compute the R, again by looking at indifference between putting and
not putting effort
                                2 y  2 R  2c  p 2 (2 y  2 R)
                                     
                                            
                                     effort          no effort

                                Rp  y 
                                                      RI
                                              1 p 2

 The repayment rate that the bank can charge under joint responsibility is
strictly larger than the repayment rate that the bank can charge under standard
bilateral contracts  LENDING BECOMES POSSIBLE!!→ efficiency gains
• Intuition: In the absence of costly effort, repayment occurs only
  when both borrowers are lucky. Each borrower's surplus is therefore
  higher, which in turn increases the scope for a competitive bank to
  charge higher repayment rates in order to break even: lending
  becomes possible→ efficiency gains

• Now, let us see what happens when there is peer monitoring

• Ex-post moral hazard models may deliver an scenario which is
  closer to what happens in reality

• Suppose that in the absence of ex post peer monitoring the “other
  borrower" will strategically default with probability 1

• Group lending with joint responsibility induces peer monitoring: each
  borrower will monitor her peer and pay a monitoring cost k

• Monitoring enables each borrower to discover true return
  realizations with probability q

• And assume that if a borrowers is found out to have defaulted
  strategically, she will have to incur “social sanctions” d
Again, let’s see the R where borrowers are borrowers are indifferent when
strategically defaulting

                                 y  R  y  q( R  d )
                                   
                                  NSD          SD


                                        q 
                                     R      d
                                       1  q 

Clearly, q  0 and/or d  0  no lending. For q to be positive when borrowers are
willing to pay the monitoring cost k (sufficiently low)

Some limitations:

Social sanctions difficult to impose on friends/relatives

Attending group meetings can be costly

Do not generally work on sparsely populated areas, k will be too high (Africa,
Latin America, Eastern Europe)

 Next class: A-M, Chapter 5: Microfinance beyond group lending

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