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Beyond Group Lending

Beyond Group Lending. Lecture # 6 Week 3. Structure of this class. Overview financial performance under GLJR and under “individual” lending Creating “dynamic incentives” Frequent repayment installments Complementary incentive mechanisms Conclusion. Creating dynamic incentives.

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Beyond Group Lending

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  1. Beyond Group Lending Lecture # 6 Week 3

  2. Structure of this class • Overview financial performance under GLJR and under “individual” lending • Creating “dynamic incentives” • Frequent repayment installments • Complementary incentive mechanisms • Conclusion

  3. Creating dynamic incentives Non –refinancing threats Assume: • 2 periods of production • Investment requires $1 to yield a return y>1 • Additional financing is needed from the microfinance lender for a second period investment

  4. Number of periods is finite  borrower does not gain anything by repaying second-period debt for example Will the borrower repay in the first period? Non-refinancing threat Again, we analyze the borrower’s decision to repay first: y + vδy ≤ y - R + δy Like in last class, above incentive compatibility constraint met If v = 0 Then: R = δy The maximum repayment that the microfinance lender can obtain from the borrower

  5. Progressive lending Now suppose that the bank can increase the size of the loan from period one to period two by λ > 1, then: The borrower now suffers a loss =λ δy > δy by not repaying And gross interest rates can be raised: R’= λ δy > R = δy while keeping borrowers “happy” (IC constraint is met)

  6. Remarks: • A “credit bureau” can help for non-refinancing threats to be effective in the advent of competition • Progressive lending should not increase loan sizes too quickly as strategic default can be triggered • It is very often difficult to persuade poor clients to take on larger-sized loans in practice

  7. Complementary incentive mechanisms • Flexible approaches to collateral • Financial collateral • Making repayments public • Targeting women • Information gathering by bank staff • Cross reporting

  8. Concluding comments • GLJR is not the only way to obtain high repayment rates on uncollateralized loans for the poor • Other mechanisms such as non-refinancing threats and progressive lending are often used in conjunction with GLJR • In a large majority of Microfinance Institutions (MFIs), borrowers are forced to save –often perceived as collateral  Next class: Armendáriz –Morduch, Chapter 6 on Savings and Insurance

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