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On the Viability of Group Lending when Microfinance Meets the Market

Author

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  • Lutz G. Arnold

    (Lutz G. Arnold, Department of Economics, University of Regensburg, Regensburg, Germany. E-mail: Lutz.Arnold@wiwi.uni-regensburg.de)

  • Johannes Reeder

    (Johannes Reeder, Department of Economics, University of Regensburg, Regensburg, Germany.)

  • Susanne Steger

    (Susanne Steger, Department of Economics, University of Regensburg, Regensburg, Germany.)

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

Suggested Citation

  • Lutz G. Arnold & Johannes Reeder & Susanne Steger, 2013. "On the Viability of Group Lending when Microfinance Meets the Market," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 12(1), pages 59-106, April.
    • Handle: RePEc:sae:emffin:v:12:y:2013:i:1:p:59-106
    DOI: 10.1177/0972652712473403
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Microfinance; group lending; enforcement; social capital; social sanctions;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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