Reviving Joint Liability Contracts: Asymmetric Joint Liability Loans and Moral Hazard

Joint liability loans are used in various settings, including business partnerships, agricultural cooperatives, and real estate investment. Most notably, they have been central to the microfinance model since the 1970s. Despite early promises, recent evidence suggests that joint liability has not consistently reduced loan defaults or operational costs. As a result, microfinance institutions (MFIs) worldwide are increasingly shifting toward individual liability contracts. A key limitation of traditional joint liability loans lies in their symmetric contract structure, which often leads to coordination failures and free-riding: while peers can enforce repayment, they may jointly default or shirk monitoring responsibilities. We propose that introducing asymmetry in joint liability contracts, by designating one group member as a lead borrower with preferential interest rates, can enhance peer monitoring and reduce moral hazard. We extend an existing theoretical model of ex-ante moral hazard (investment behavior) to the scenario of hazard (strategic default) and evaluate both frameworks through a lab-in-the-field experiment with microfinance clients in urban Bolivia. Our experimental results show that asymmetric contracts significantly increase peer monitoring by 17-20% in both moral hazard scenarios. These findings suggest that asymmetric group lending contracts offer a promising path to reviving joint liability in microfinance.