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Moral Hazard and Peer Monitoring in a Laboratory Microfinance Experiment

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  • Timothy N. Cason
  • Lata Gangadharan
  • Pushkar Maitra

Abstract

Most problems with formal sector credit lending to the poor in developing countries can be attributed to the lack of information and inadequate collateral. One common feature of successful credit mechanisms is group-lending, where the loan is advanced to an individual if he/she is a part of a group and members of the borrowing group can monitor each other. Since group members have better information about each other compared to lenders, peer monitoring is often less expensive than lender monitoring. Theoretically this leads to greater monitoring and greater rates of loan repayments. This paper reports the results from a laboratory experiment of group lending in the presence of moral hazard and (costly) peer monitoring. We compare peer monitoring treatments when credit is provided to members of the group sequentially and simultaneously, and individual lending with lender monitoring. The results depend on the relative cost of monitoring by the peer vis-à-vis the lender. In the more typical case where the cost of peer monitoring is lower than the cost of lender monitoring, our results suggest that peer monitoring results in higher loan frequencies, higher monitoring and higher repayment rates compared to lender monitoring. In the absence of monitoring cost differences, performance is mostly similar across group and individual lending schemes, although loan frequencies and monitoring rates are sometimes modestly greater with group lending. Within group lending, although the dynamic incentives provided by sequential leading generate the greatest equilibrium surplus, simultaneous group leading provides equivalent empirical performance.

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Bibliographic Info

Paper provided by Purdue University, Department of Economics in its series Purdue University Economics Working Papers with number 1208.

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Length: 48 pages
Date of creation: Mar 2008
Date of revision:
Handle: RePEc:pur:prukra:1208

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Keywords: Group Lending; Monitoring; Moral Hazard; Laboratory Experiment; Loans; Development;

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References

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Citations

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Cited by:
  1. Nargiza Maksudova, 2009. "Microfinance in Uzbekistan : market overview and impact assessment needs," Memoranda - Policy Papers 39, Institut für Ost- und Südosteuropaforschung (Institute for East and South-East European Studies).
  2. Wei Zhang & Haifeng Li & Shigenori Ishida & Eric Park, 2010. "China’s Non-governmental Microcredit Practice: History and Challenges," Journal of Family and Economic Issues, Springer, vol. 31(3), pages 280-296, September.
  3. Jean-Marie Baland & Lata Gangadharan & Pushkar Maitra & Rohini Somanathan, 2013. "Repayment and Exclusion in a Microfinance Experiment," Monash Economics Working Papers 12-13, Monash University, Department of Economics.
  4. Jeffrey Carpenter & Tyler Williams, 2010. "Moral hazard, peer monitoring, and microcredit: field experimental evidence from Paraguay," Working Papers 10-6, Federal Reserve Bank of Boston.
  5. Peter Werner, 2010. "The Dynamics of Cooperation in Group Lending - A Microfinance Experiment," Working Paper Series in Economics 49, University of Cologne, Department of Economics.

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