Section 2, Team 7: Microfinance and Impact InvestingBen Horwitz, Everett Mattox, Nicolas de Narvaez, Katie Parker, Victoria Huang, Prakhar Agrawal

Q1a) Group lending process:

Problems it solves Problems it createIssue of loan delinquency is mitigated by the sense of individual accountability to the group. The social pressure of not defaulting on the loan will ensure that individual have the sense of responsibility to repay the loans on time

It creates the “Free-rider” problem in which people not directly managing the business are held accountable for loan repayments. This leads to more risk-seeking behavior among individuals as the default risk is divided in the community.

The risk of default is reduced by the allocation of loan amount to the group rather than an individual

In a group setting, preferential treatment could be given in loan approval and the amount of loan.

It reduces the information cost for financial institutions as the local knowledge of group members will help in accurate loan pricing. It also reduces the search cost because the group ensures that only feasible business are approved for loans.

The negotiation costs are higher as an individual needs to go through multiple stages of loan approval.

1) Individual needs to convince the community members for getting the loan for their business. This is an added step in the lending process.

2) Individual need to convince the financial institution to provide the loan for their business.

Q1b) Single person lending:

Pros ConsThe autonomy in decision making starting from loan approval to how the loan money is used makes the entire process much faster.

The enforcement costs are higher for financial institutions as an individual can default or escape responsibility whereas in group lending, the entire group has to default.

In a scenario when a business is successful, the loan can be paid-off faster and the business can be scaled quickly by borrowing more money if required.

Overall lack of scrutiny from diverse perspectives in single-person lending can lead to poor decision making.

Lack of group favoritism (preferential treatment) leads to lesser corruption in lending process and reduces transaction cost.

There is greater risk in single person lending because individual can lose their entire collateral when a business fails. However in a group setting, the group has to default as a whole for losing the collateral.