Microfinance Beyond Group Lending

This paper explores the challenges faced by transition economies in finding ways to raise incomes of low-income households and to broaden financial markets. It reiterates the success of microfinance towards fulfilling these objectives. The paper argues, though, that microfinance has been tied closely to the idea of group-lending with joint liability.The paper draws from the experiences of new programs in Russia and Eastern Europe and suggests that:

• Group lending model may be a poor fit for potential clients in transition economies
• Employing individual-based contracts instead of only using group lending contracts may prove advantageous in transition economies;
• Experiences with group lending offer important lessons for the design of individual based credit contracts even for wealthier clients in transition economies.

Further, the article describes mechanisms that allow microlending programs to generate high repayment rates from low-income borrowers without requiring collateral and without using group lending contracts:

• Direct monitoring;
• Regular repayment schedules;
• Use of non-refinancing threats.

Thus, the paper fulfills two principal objectives of:

• Using new insights from the economic theory of contracts to formally characterize central mechanisms behind the new individual-based programs;
• Illustrating fundamental similarities between programs based on group contracts and those based on individual contracts.