The Role of Group Size and Correlated Project Outcomes in Group Lending

Marina Markheim

doi:10.4236/tel.2017.75080

Abstract

This paper analyzes contract efficiency with regard to correlated project realization and the size of the borrowers in group lending. Firstly, I show that under the standard assumption of independent project payoffs, the expected group cost of default decreases with group size. Secondly, I show that small groups can also optimize group efficiency if individual payoffs and credit risks are correlated. The results outline that social cost minimization occurs due to a common interest in forming optimal borrower groups between lenders and borrowers.

Highlights

The United Nations recognizes the importance of microfinance as a major tool for achieving Millennium Development Goals
Microfinance institutions (MFIs) use diverse models to provide micro loans. Most of these microfinance institutions (MFIs) models are based on group lending and known as the Joint Liability Group (JLG)
Baland et al, (2013) [9] explored interaction between group size, wealth and projects characteristics. They showed, that a small group size can increase efficiency when access to credit is limited by strategic default and found that group lending with two borrowers in never optimal for small loans but the benefit is not monotonic

Summary

Introduction

Baland et al, (2013) [9] explored interaction between group size, wealth and projects characteristics They showed, that a small group size can increase efficiency when access to credit is limited by strategic default and found that group lending with two borrowers in never optimal for small loans but the benefit is not monotonic. [10] assumed that project are statistically independent and shown in the adverse selection, the ex ante moral hazard and the ex post moral hazard settings, how the effect of group size varies with social capital. This paper provides the novel theoretical explanation of a strong relationship between correlated project outcomes and group size while focuses on the limited abilities of risk sharing within the homogeneous group. I present some concluding remarks and discuss potential implications for future research

The Basic Model

The Correlated Project Realization

Efficiency Lending Contracts with n Borrowers

Numerical Example

Conclusions