Lending to the Unbankable - Dynamic Incentives and Joint Liability in a Trust Game with Social Collateral

Abstract

Existence of asymmetric information and lack of collateral in informal financial markets creates a suboptimal allocation of financial resources to those in most need. When borrowers (safe and risky), approach financial institutions, the presence of moral hazard and adverse selection results in no lending. Conversely, group borrowing - either individual under joint liability contract or group based - generating a trust game between borrowers, controls for information asymmetries and creates a cooperative trust game with an undominated optimal solution to repay, and therefore for the lender to Give. MC programs based on group lending under joint liability, dynamic lending and with social cost for defaulting contracts prove superior to typical individual borrowing and lending when no collateral is available. These contracts and correspondent payoffs are Pareto Efficient.