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When is the optimal lending contract in microfinance state non-contingent?

  • Jeon, Doh-Shin
  • Menicucci, Domenico

Whether a microfinance institution should use a state-contingent repayment or not is very important since a state-contingent loan can provide insurance for borrowers. However, the classic Grameen bank used state non-contingent repayment, which is puzzling since it forces poor borrowers to make their payments even under hard circumstances. This paper provides an explanation to this puzzle. We consider two modes of lending, group and individual lending, and for each mode we characterize the optimal lending and supervisory contracts when a staff member (a supervisor) can embezzle borrowers' repayments by misrepresenting realized returns. We identify the main trade-off between the insurance gain and the cost of controlling the supervisor's misbehavior. We also find that group lending dominates individual lending either by providing more insurance or by saving audit costs.

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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 55 (2011)
Issue (Month): 5 (June)
Pages: 720-731

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Handle: RePEc:eee:eecrev:v:55:y:2011:i:5:p:720-731
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  17. 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.
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