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Group Lending and Endogenous Social Sanctions

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  • Jean-Marie Baland
  • Rohini Somanathan
  • Zaki Wahhaj

    ()

Abstract

In recent years, microfinance institutions have expanded into group lending with individual liability, leaving out the joint liability clause which was an important feature in earlier lending contracts. Recent experimental evidence indicates that group lending may yield benefits, specifically lowering default rates, even in the absence of joint liability. In this paper, we develop a theoretical model where the public nature of group meetings means that borrowers have incentives to repay a group loan to safeguard their reputation. We show that the introduction of group loans with individual liability will cause sorting between joint liability and individual liability group loans. Specifically, borrowers who attach more importance to their reputation will select into individual liability loans, causing default rates and interest rates to rise for joint liability loans. The introduction of group loans with individual liability can even make joint liability loans infeasible in equilibrium.

Suggested Citation

  • Jean-Marie Baland & Rohini Somanathan & Zaki Wahhaj, 2014. "Group Lending and Endogenous Social Sanctions," Studies in Economics 1415, School of Economics, University of Kent.
  • Handle: RePEc:ukc:ukcedp:1415
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    References listed on IDEAS

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    1. Baland, Jean-Marie & Somanathan, Rohini & Wahhaj, Zaki, 2013. "Repayment incentives and the distribution of gains from group lending," Journal of Development Economics, Elsevier, vol. 105(C), pages 131-139.
    2. de Quidt, Jonathan & Fetzer, Thiemo & Ghatak, Maitreesh, 2016. "Group lending without joint liability," Journal of Development Economics, Elsevier, vol. 121(C), pages 217-236.
    3. Besley, Timothy & Coate, Stephen, 1995. "Group lending, repayment incentives and social collateral," Journal of Development Economics, Elsevier, vol. 46(1), pages 1-18, February.
    4. 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.
    5. Benjamin Feigenberg & Erica Field & Rohini Pande, 2013. "The Economic Returns to Social Interaction: Experimental Evidence from Microfinance," Review of Economic Studies, Oxford University Press, vol. 80(4), pages 1459-1483.
    6. Abhijit V. Banerjee & Timothy Besley & Timothy W. Guinnane, 1994. "Thy Neighbor's Keeper: The Design of a Credit Cooperative with Theory and a Test," The Quarterly Journal of Economics, Oxford University Press, vol. 109(2), pages 491-515.
    7. Giné, Xavier & Karlan, Dean S., 2014. "Group versus individual liability: Short and long term evidence from Philippine microcredit lending groups," Journal of Development Economics, Elsevier, vol. 107(C), pages 65-83.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Microfinance; Group Lending; Joint Liability; Social Sanctions; Reputation;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • O12 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Microeconomic Analyses of Economic Development
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty

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