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Group lending as a mechanism for self-insuring default risk

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  • Andreas Krause

    (University of Bath)

Abstract

We show that banks can provide loans at low costs to high-risk borrowers in the form of a group lending contract in which all members are jointly liable for their loans. By providing such contracts borrowers self-insure against some of the default risk the bank faces. We determine the optimal group size in a competitive banking system and find that it is reasonably small and borrowers internalize an increasing fraction of the risk the higher their risks are.

Suggested Citation

  • Andreas Krause, 2025. "Group lending as a mechanism for self-insuring default risk," Annals of Finance, Springer, vol. 21(1), pages 97-106, March.
    • Handle: RePEc:kap:annfin:v:21:y:2025:i:1:d:10.1007_s10436-024-00447-4
    DOI: 10.1007/s10436-024-00447-4
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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