School of Economics

2014 Discussion papers

School of Economics Discussion Paper 14/15

Group Lending and Endogenous Social Sanctions

Jean-Marie Baland, Rohini Somanathan and Zaki Wahhaj
University of Namur, Delhi School of Economics and University of Kent

December 2014


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.

JEL Classification: G21; O12; O16; D8

Keywords: Microfinance; Group Lending; Joint Liability; Social Sanctions; Reputation

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Last Updated: 12/03/2015