Exploiting Social Networks to Alleviate Credit Market Failures: On the Endogenous Selection of Peer Groups in Microfinance Programs

This paper focuses on two specific issues related to self-selection of borrowers into microfinance programs that use joint liability.

The first issue refers to the theoretical question of whether joint liability can be considered as an incentive device for borrowers to self select groups on the basis of locally available information. The second refers to the endogeneity problems when analyzing the effects of social networks on lending outcomes such as repayment rates.

Studies show that social cohesion and better information flow among group members result in improved repayment rates in microfinance programs using joint liability. However, group composition is endogenous and borrowers have a choice in joining a joint liability program. The paper discusses various aspects of the resulting endogeneity problem, and how empirical researchers have attempted to address it.