Microfinance and Mechanism of Group Lending: Theory and Experiences

Abstract

It is generally accepted that the micro-finance sector emerged as an answer to financial market failures. In this context, the paper examines the basic idea on which micro-finance is built and sees how it is different from the mainstream financial service providers. The present paper therefore, deals with the theoretical framework of microfinance including definition, economics and mechanism of group lending, gender aspects and limitations of microfinance. One of the major features of microfinance is group lending where the concept of joint-liability helps in mitigating problems caused by adverse selection and moral hazard. Other important mechanisms, besides group lending, are the use of dynamic incentives, collateral substitutes, and regular repayment schedules, the targeting of women and social programmes which, according to theory, play a significant role. The paper also discusses about the relation between the models of Joint Liability Group lending. There has been considerable debate over whether micro-finance can reach the ‘poorest of the poor’ and it has also been highlighted in the paper. The micro-finance programme is ideologically designed to achieve women's contribution to family welfare and assist poor women to obtain socio-economic empowerment, but often the positional vulnerability of the women is exploited at the time of repayment. Thus the paper also highlights the limitations of micro-finance forwarded by Ohio School of Development Finance which stated that debt is not an effective tool for helping most of poor people to enhance their economic conditions as they operate in small farms or micro enterprises.