Group lending : an approach to eradicate poverty

Abstract

This thesis concentrates on group lending, which is considered a major force behind the successful operation of microcredit institutions. This research explores group-lending mechanisms and group-formation techniques which improve repayment performance and reduce group failures. Group-lending microcredit institutions lend to low-income groups who cannot offer collateral. By making a group of borrowers jointly responsible for loan repayments, the idea of social collateral has gained credence. The Grameen Model uses this as a substitute for physical collateral. An alternative group-lending model, Self-Help Group (SHG) requires members to save first to meet a certain threshold level of savings. This process helps to develop and strengthen bonds among members of the group while pooling their savings. These savings serve as partial physical collateral and provide an incentive to repay loans. In the first of the three long essays that form the body of this research, the distinctive features of both the Grameen Model and the SHG Model are compared through laboratory experiments to identify the mechanisms that can improve repayment performance. The results indicate that the joint impact of both social and partial physical collateral is of far more benefit than the individual impact of either. Using an experimental approach, the second essay explores the impact of social ties on group solidarity. Group solidarity is expressed in terms of meeting the threshold level of group contribution. The results indicate that social proximity among members enhances group contribution and, thus, may help in the voluntary provision of the public good. In the context of Self-Help Group lending, members need to save first and then seek access to loans from banks against these savings. We find that social ties make it easier for the group to reach the threshold level of savings and thus procure partial physical collateral, which in turn increases repayment performance. This result may have ramifications for group-lending institutions as well as for the provision of a public good that relies on group contributions. The existing literature shows that joint liability and self -selection of group members results in homogeneous group formation in terms of the risk characteristics of the borrower's project. In the third essay we develop a theoretical model to demonstrate the feasibility of heterogeneous group formation. We consider the impact of different forms of intra-group transfers on group formation and find that only a particular form of intra-group transfer, referred to as indirect joint liability and revenue sharing (IJLRS), results in heterogeneous group formation. This may serve as an informal intra-group insurance mechanism. Overall, this thesis increases our understanding of the group-lending strategies of microfinance institutions. The results obtained in this thesis can be used by policy makers and microfinance institutions. The ultimate aim is for microfinance institutions to be able to increase their outreach, in order to help more people get out of poverty.