Efficient Microlending without Joint Liability

Altınok, Ahmet and Sever, Can (2014): Efficient Microlending without Joint Liability.

Abstract

Peer-group mechanisms have been widely used by micro-credit institutions to minimize default risk. However, there are costs associated with establishing and maintaining liability groups. In the case when output is fully observable, we propose a dynamic individual lending mechanism. Assuming that risky borrowers discount the future costs and benefits relatively higher, our mechanism performs equally well in repayment rates, distinguishes safe and risky borrowers through differentiated interest rates and payment schedules. In case of unobservable types, it is able to eliminate adverse selection problem, and it reaches the first best outcome of the case that types of borrowers are publicly known. It improves wealth of individuals, and hence achieves a net welfare-superior outcome when compared with joint liability. Individual lending further saves from internal costs of group formation, and broadens the fractions of society into which microfinance institutions penetrate. We also identify unique welfare maximizing contract in our mechanism. Finally, we introduce a history dependent success probabilities, and show existence of efficient individual contract in that environment.

• Item Type: MPRA Paper
• Language: English
• Keywords: Microfinance, Graamen bank, joint liability, adverse selection, microlending, group lending, individual lending
• Subjects: D - Microeconomics > D6 - Welfare Economics > D60 - General; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D86 - Economics of Contract: Theory; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O12 - Microeconomic Analyses of Economic Development

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