Microfinance and Mechanism Design: The Role of Joint Liability and Cross-Reporting
AbstractSince 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 InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 23934.
Date of creation: 10 Jul 2009
Date of revision: 12 Jan 2010
Microfinance; mechanism design; joint liability; cross-reporting;
Find related papers by JEL classification:
- B21 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Microeconomics
- N20 - Economic History - - Financial Markets and Institutions - - - General, International, or Comparative
- C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-07-24 (All new papers)
- NEP-BAN-2010-07-24 (Banking)
- NEP-CTA-2010-07-24 (Contract Theory & Applications)
- NEP-MFD-2010-07-24 (Microfinance)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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