Abstract
This paper studies group lending with joint-liability contracts offered by Microfinance Institutions (MFIs). We develop a model of group lending where heterogeneous agents form groups, obtain capital from the MFI, and share risks among themselves. We show that the composition of the groups is not always homogeneous once risk-sharing is introduced, rationalizing the empirical evidence of risk heterogeneity within groups. Moreover, we find that joint liability introduces inefficiency for risk-averse borrowers, which explains why MFIs are moving away from joint-liability contracts. Surprisingly, the first-best outcome can be achieved even in the presence of information asymmetry.
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