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Repayment incentives and the distribution of gains from group lending

  • Baland, Jean-Marie
  • Somanathan, Rohini
  • Wahhaj, Zaki

Group loans with joint liability are a distinguishing feature of many microfinance programs. While such lending benefits millions of borrowers, major lending institutions acknowledge its limited impact among the very poor and have shifted towards individual loans. This paper attempts to explain this trend by exploring the relationship between borrower wealth and the benefits from group lending when access to credit is limited by strategic default. In our model, individuals of heterogeneous wealth face a given investment opportunity so poor investors demand larger loans. We show that the largest loan offered as an individual contract cannot be supported as a group loan. Joint liability cannot therefore extend credit outreach in the absence of additional social sanctions within groups. We also find that the benefits from group loans are increasing in borrower wealth and that optimal group size depends on project characteristics. By allowing for multi-person groups and wealth heterogeneity in the population, the paper extends the standard framework to analyze joint liability and contributes to an understanding of the conditions under which microcredit can reduce poverty.

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Article provided by Elsevier in its journal Journal of Development Economics.

Volume (Year): 105 (2013)
Issue (Month): C ()
Pages: 131-139

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Handle: RePEc:eee:deveco:v:105:y:2013:i:c:p:131-139
Contact details of provider: Web page: http://www.elsevier.com/locate/devec

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  1. Jonathan Morduch, 1998. "Does Microfinance Really Help the Poor? New Evidence from Flagship Programs in Bangladesh," Working Papers 198, Princeton University, Woodrow Wilson School of Public and International Affairs, Research Program in Development Studies..
  2. Xavier Giné & Dean Karlan, 2009. "Group versus Individual Liability: Long Term Evidence from Philippine Microcredit Lending Groups," Working Papers 970, Economic Growth Center, Yale University.
  3. Bond, Philip & Rai, Ashok S., 2008. "Cosigned vs. group loans," Journal of Development Economics, Elsevier, vol. 85(1-2), pages 58-80, February.
  4. Thiemo Fetzer & Maitreesh Ghatak & Jonathan de Quidt, 2012. "Market Structure and Borrower Welfare in Microfinance," STICERD - Economic Organisation and Public Policy Discussion Papers Series 40, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
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  7. Abbink, Klaus & Bernd Irlenbusch & Elke Renner, 2002. "Group Size and Social Ties in Microfinance Institutions," Royal Economic Society Annual Conference 2003 1, Royal Economic Society.
  8. Christian Ahlin & Robert Townsend, 2003. "Selection into and across Credit Contracts: Theory and Field Research," Vanderbilt University Department of Economics Working Papers 0323, Vanderbilt University Department of Economics.
  9. Kiminori Matsuyama, 1998. "Endogenous Inequality," Discussion Papers 1238, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  10. Abhijit V. Banerjee & Andrew F. Newman, 1990. "Occupational Choice and the Process of Development," Discussion Papers 911, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. Alessandra Cassar & Luke Crowley & Bruce Wydick, 2007. "The effect of social capital on group loan repayment: evidence from field experiments," Economic Journal, Royal Economic Society, vol. 117(517), pages F85-F106, 02.
  12. Hermes, Niels & Lensink, Robert, 2011. "Microfinance: Its Impact, Outreach, and Sustainability," World Development, Elsevier, vol. 39(6), pages 875-881, June.
  13. 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.
  14. Dean Karlan & Jonathan Zinman, 2005. "Observing unobservables: identifying information asymmetries with a consumer-credit field experiment," Proceedings 961, Federal Reserve Bank of Chicago.
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  16. repec:pri:rpdevs:morduch_microfinance_poor is not listed on IDEAS
  17. Bhole, Bharat & Ogden, Sean, 2010. "Group lending and individual lending with strategic default," Journal of Development Economics, Elsevier, vol. 91(2), pages 348-363, March.
  18. Dewan, Isha & Somanathan, Rohini, 2011. "The application of nonparametric tests to poverty targeting," Economics Letters, Elsevier, vol. 113(1), pages 58-61, October.
  19. Coleman, Brett E., 2006. "Microfinance in Northeast Thailand: Who benefits and how much?," World Development, Elsevier, vol. 34(9), pages 1612-1638, September.
  20. Ashok S. Rai & Tomas Sjöström, 2004. "Is Grameen Lending Efficient? Repayment Incentives and Insurance in Village Economies," Review of Economic Studies, Oxford University Press, vol. 71(1), pages 217-234.
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