Microfinance Beyond Group Lending• In the last class we argued that

a) under the threat of not being refinanced by the MFI, and

b) 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

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

At the end of the first period:

R = δy (1- v)

which is maximized when bank sets v = 0

→ R = δy

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 defaultuntil loan sizes have grown substantially unless there are reputation considerations (absent from this simple model)

Remark # 2: Competition undermines a “progressive lending device”

Frequent Repayment Installments

Explanations:

a) “Early warning” system

b) “Saving constraints”

c) 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

Targeting women

• More reliable than men

• More “cautious”

• More sensitive to verbal hostility

• Have fewer alternative sources of credit

2) Innovations not seen in group lending

Collateral

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

Information gathering by bank staff

And

Cross Reporting

Now, when comparing group – lending contracts with bilateral contracts we find the following:

→ Next class: A-M Chapter 8