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Microfinance and Mechanism Design: The Role of Joint Liability and Cross-Reporting

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  • Abdul Karim, Zulkefly

Abstract

Since the establishment of Grameen Bank in 1976 by Professor Muhammad Yunus , many economists have studied extensively, either theoretically or empirically, the success of the Grameen Bank in eradicating the poverty problem in Bangladesh. Therefore, this paper aims to apply the mechanism design theory in microfinance by examining the role of joint liability and cross-reporting mechanism in the loan contract which designing by microfinance lender. In doing so, this study simplified the joint liability mechanism proposed by Ghatak (1999, 2000) and cross-reporting mechanism by Rai and Sjostrom (2004). Based on the joint-liability mechanism, it is clearly stated that the microfinance lender can minimize or avoid the adverse selection problem in the credit market through peer selection and peer screening. In the meantime, the joint liability mechanism is better than individual lending in terms of increasing the social welfare among the poor borrower, charging lower interest rates and generating high repayment rates. In contrast, Rai and Sjostrom (2004) argue that joint liability alone is not enough to efficiently induce borrowers to help each other. Indeed, the cross-reporting mechanism is also important for lenders in order to minimize the problem of asymmetric information in the credit market. The cross-reporting mechanism is also efficient because it can influence the borrower to be truthful-telling about the state of the project and subsequently can minimize the deadweight loss (punishment) among the borrowers. In comparison, without cross-reporting, the lending mechanism is inefficient because the borrower will be imposed harsh punishment from the bank and the bank can undertake auditing or verify the state of the project and punish accordingly.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 23934.

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Date of creation: 10 Jul 2009
Date of revision: 12 Jan 2010
Handle: RePEc:pra:mprapa:23934

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Keywords: Microfinance; mechanism design; joint liability; cross-reporting;

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References

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  1. Eric Maskin & Tomas Sjostrom, 2001. "Implementation Theory," Economics Working Papers 0006, Institute for Advanced Study, School of Social Science.
  2. Jain, Sanjay & Mansuri, Ghazala, 2003. "A little at a time: the use of regularly scheduled repayments in microfinance programs," Journal of Development Economics, Elsevier, vol. 72(1), pages 253-279, October.
  3. Beatriz Armendariz & Jonathan Morduch, 2007. "The Economics of Microfinance," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262512017, December.
  4. Robert M. Townsend, 2003. "Microcredit And Mechanism Design," Journal of the European Economic Association, MIT Press, vol. 1(2-3), pages 468-477, 04/05.
  5. Beatriz Armendáriz de Aghion & Jonathan Morduch, 2000. "Microfinance Beyond Group Lending," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 8(2), pages 401-420, July.
  6. Ghatak, Maitreesh & Guinnane, Timothy W., 1999. "The economics of lending with joint liability: theory and practice," Journal of Development Economics, Elsevier, vol. 60(1), pages 195-228, October.
  7. Ghatak, Maitreesh, 1999. "Group lending, local information and peer selection," Journal of Development Economics, Elsevier, vol. 60(1), pages 27-50, October.
  8. James C. Brau & Gary M. Woller, 2004. "Microfinance: A Comprehensive Review of the Existing Literature," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 9(1), pages 1-28, Spring.
  9. Guinnane, T. & Banerjee, A. & Besley, T., 1993. "Thy Neighbor's Keeper: the Design of a Credit Cooperative with Theory and a Test," Papers 705, Yale - Economic Growth Center.
  10. Chowdhury, Prabal Roy, 2005. "Group-lending: Sequential financing, lender monitoring and joint liability," Journal of Development Economics, Elsevier, vol. 77(2), pages 415-439, August.
  11. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
  12. Jonathan Morduch, 1999. "The Microfinance Promise," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1569-1614, December.
  13. Stiglitz, Joseph E, 1990. "Peer Monitoring and Credit Markets," World Bank Economic Review, World Bank Group, vol. 4(3), pages 351-66, September.
  14. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  15. Rajdeep Sengupta & Craig P. Aubuchon, 2008. "The microfinance revolution: an overview," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 9-30.
  16. Jonathan Conning, 2000. "Monitoring by Peers or by Delegates? Joint Liability Loans under Moral Hazard," Department of Economics Working Papers 2000-07, Department of Economics, Williams College.
  17. de Aghion, Beatriz Armendariz & Gollier, Christian, 2000. "Peer Group Formation in an Adverse Selection Model," Economic Journal, Royal Economic Society, vol. 110(465), pages 632-43, July.
  18. Ashok S. Rai & Tomas Sj–str–m, 2004. "Is Grameen Lending Efficient? Repayment Incentives and Insurance in Village Economies," Review of Economic Studies, Wiley Blackwell, vol. 71(1), pages 217-234, 01.
  19. Laffont, Jean-Jacques & N'Guessan, Tchetche, 2000. "Group lending with adverse selection," European Economic Review, Elsevier, vol. 44(4-6), pages 773-784, May.
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