Group Lending Microfinance

Lecture # 5Week 3

Structure of this class

• Description of “the classic” GLJR contract

• Overcoming adverse selection

• Overcoming moral hazard

• Evidence

• Limitation of the GLJR contracts

• Some background

First experiments in Jobra near Chittnagong University. Loans made to individuals

M. Yunus and associates soon realized that extending loans to groups had the following advantages: economies of scale, and saving in screening, monitoring and enforcing

Description of the GLJR contract

Like ROSCAs and Credit Cooperatives

Early microfinance institutions involved groups

Each participant borrower responsible for the debt of others

Loans are granted individually

If entire group’s debt is not repaid, all individuals are excluded from future refinancing

Common wisdom: incidence of default is reduced because participant borrowers are in a relatively superior position to screen, monitor and enforce repayments due to geographical proximity and other links

Delegation of agency problems due to asymmetric information from microfinance lenders to the borrowers efficiency

Overcoming Adverse Selection

Assume:

• Each individual has a one-period project requiring $1 investment

•There are two types of borrowers: “safe” and “risky”

•Fraction of the population that is safe is q<1, and risky 1-q

•A dollar invested by a safe borrower yields y with certainty and a a dollar invested by a risky borrower yields with probability p

There will be assortative matching (s,s) and (r, r) and:

where g is the probability of luck in a risky pair

And the break even rate:

Which is smaller than the break even rate in the absence of GLJR

Intuition: the risky types can repay back their loans more often thanks to GLJR.

Risk passed on from bank to risky borrowersInterest rates can be reducedDeserving safe types back into the market

Overcoming Ex Ante Moral Hazard

Some evidence

• BRAC

• VO

• Finca

• ProMujer

• Lab Experiments

Some Limitations

Next class: A-M Chapter 5