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Optimal (partial) group liability in microfinance lending

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  • Allen, Treb
Abstract
This paper develops a model of group borrowing that incorporates partial group liability, where borrowers are penalized if their group members default but are not held responsible for the entirety of the failed loan. The model illustrates a trade-off of group liability lending: while higher levels of group liability increase within group risk-sharing, if liability is too high, borrowers strategically default. The model predicts the existence of an optimal partial liability that maximizes transfers between group members while avoiding strategic default. Consistent with this prediction, loan officers from a large microfinance institution in southern Mexico who rarely allow one group member to repay while the other defaults achieve substantially lower default rates than loan officers for whom the practice is commonplace or for those for whom it has never occurred. Structural estimation using repayment data suggests that while a partial liability below full liability may reduce default rates, the incidence of strategic default is rare.

Suggested Citation

  • Allen, Treb, 2016. "Optimal (partial) group liability in microfinance lending," Journal of Development Economics, Elsevier, vol. 121(C), pages 201-216.
    • Handle: RePEc:eee:deveco:v:121:y:2016:i:c:p:201-216
    DOI: 10.1016/j.jdeveco.2015.08.002
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    References listed on IDEAS

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    2. de Quidt, Jonathan & Fetzer, Thiemo & Ghatak, Maitreesh, 2018. "Commercialization and the decline of joint liability microcredit," Journal of Development Economics, Elsevier, vol. 134(C), pages 209-225.
    3. Goedecke, Jann, 2018. "Contagious loan default," Economics Letters, Elsevier, vol. 170(C), pages 14-18.
    4. Khushbu Mishra & Richard A. Gallenstein & Mario J. Miranda & Abdoul G. Sam & Patricia Toledo & Francis Mulangu, 2021. "Insured Loans and Credit Access: Evidence from a Randomized Field Experiment in Northern Ghana," American Journal of Agricultural Economics, John Wiley & Sons, vol. 103(3), pages 923-943, May.
    5. Singh, Nirvikar, 2018. "Financial Inclusion: Concepts, Issues and Policies for India," Santa Cruz Department of Economics, Working Paper Series qt98p5m37s, Department of Economics, UC Santa Cruz.
    6. Cao, Bin & Zhong, Yuanguang & Zhou, Yong-Wu, 2024. "The role of completely joint liability in financing multiple capital-constrained firms: Risk sharing, inventory and financial strategies," European Journal of Operational Research, Elsevier, vol. 313(3), pages 1072-1087.
    7. Bahar Rezaei & Sriram Dasu & Reza Ahmadi, 2017. "Optimal Group Size in Joint Liability Contracts," Decision Analysis, INFORMS, vol. 14(3), pages 204-225, September.
    8. Jennifer G. Fronda, 2024. "Empowering Nueva Ecija’s Farmers through Microfinancing: A Blueprint for Enhancing Financial Literacy and Agricultural Resilience," International Journal of Economics and Financial Issues, Econjournals, vol. 14(4), pages 123-130, July.
    9. de Quidt, Jonathan & Fetzer, Thiemo & Ghatak, Maitreesh, 2016. "Group lending without joint liability," Journal of Development Economics, Elsevier, vol. 121(C), pages 217-236.
    10. Hameem Raees Chowdhury, 2016. "Joint-Liability in Microcredit: Evidence from Bangladesh," Atlantic Economic Journal, Springer;International Atlantic Economic Society, vol. 44(1), pages 105-129, March.
    11. Fujimoto, Junichi & Lee, Junsang, 2020. "Optimal self-financing microfinance contracts when borrowers have risk aversion and limited commitment," Journal of Mathematical Economics, Elsevier, vol. 91(C), pages 60-79.

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