Moral Hazard and Repayment Performance Under Group Lending

This paper seeks to analyze repayment performance of group lending. It develops a model of the strategic interaction of borrowers (game) in the group lending framework, in an environment characterized by moral hazard. As per the paper, most of the explanations for higher repayment in group lending focus on informational advantages possessed by members of group lending programs:

• The first type of informational advantage is related to adverse selection,
• The second is related to ex ante moral hazard - information on utilization and efforts of the borrower for success.

The author contends that due to the complexity of ex ante moral hazard, the existing literature has imposed very strong simplifying assumptions. These are avoided in the presented model, at the cost of additional complexity. On account of this complexity, the model is not established using analytical proofs, but is only illustrated using numerical simulations. The paper investigates:

• The base case where group members cannot monitor fellow members.
• The effects of allowing monitoring and changing group size.

The model shows that:

• The efforts put in by the borrowers for success of their projects are more for individual lending.
• The degree of joint liability in a group reduces the individual efforts.
• Monitoring is not necessary to enable the success of group lending this it proves through simulation.
• Even without monitoring, the expected repayment revenue received by the lending institution under joint liability can compare favorably with that under individual liability, despite lower individual effort levels under joint liability.
• For the lending institution, the repayment revenue increases with the degree of joint liability and loan size. Therefore, 100 percent joint liability appears optimum, when the loans received by the group are repaid even when the project of one of the borrowers fails.