Repayment incentives and the distribution of gains from group lending

Jean-Marie Baland, Rohini Somanathan, Zaki Wahhaj

Research output: Contribution to journalArticlepeer-review

Abstract

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.

Original languageEnglish
Pages (from-to)131-139
Number of pages9
JournalJournal of Development Economics
Volume105
DOIs
Publication statusPublished - 1 Nov 2013

Keywords

  • Group lending
  • Joint-liability
  • Microcredit
  • Repayment incentives
  • Social sanctions

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