Microfinance Beyond Group Lending

1. Microfinance Beyond Group Lending • In the last class we argued that • under the threat of not being refinanced by the MFI, and • under the threat of social sanctions, group–lending can potentially circumvent credit market imperfections • Is successful implementation of the group-lending methodology only possible in densely populated areas and close – knit societies? No. In particular, in today’s class we will argue that there are other innovations: 1) Some peculiar to group – lending à la Grameen, but that do not hinge on group lending per se 2) Some that do not involve groups at all

2. 1) Innovations that already exists in group - lending Progressive lending Assume two periods of production An investment requires $1 And at the end of each period the borrower generates y > $1 If the borrower defaults strategically, she will not be able to invest in the second period As before, we use the same methodology to determine R y + vδy = y - R + δy

3. At the end of the first period: R = δy (1- v) which is maximized when bank sets v = 0 → R = δy

4. Now suppose progressive lending like group – lending à la Grameen Is good for incentives as it increases the opportunity cost of non-repayment λ δy > δy And: R’= λ δy > R = δy Remark # 1: In a multi-period model borrowers can wait to strategically default until loan sizes have grown substantially unless there are reputation considerations (absent from this simple model) Remark # 2: Competition undermines a “progressive lending device”

5. Frequent Repayment Installments

6. Explanations: • “Early warning” system • “Saving constraints” • Capture household flows earlier Remark # 1: Transactions costs need to be relatively low Remark # 2: Seasonality in agricultural areas is a problem And, in general, covariant risk in agriculture is a major problem

7. Targeting women • More reliable than men • More “cautious” • More sensitive to verbal hostility • Have fewer alternative sources of credit

8. 2) Innovations not seen in group lendingCollateral

9. Public Repayments Some advantages from the lender’s standpoint: • Threat of stigma • Transaction costs are reduced • Eliciting information about errant borrowers • Facilitates education and training • Encourages inexperienced borrowers to approach the bank • Enhancement of internal control and lower incidence of fraud

10. Information gathering by bank staff And Cross Reporting

11. Now, when comparing group – lending contracts with bilateral contracts we find the following: → Next class: A-M Chapter 8