Reputation, Trust and the Logic of Group Lending

This paper aims to demonstrate the synergy between microcredit programs and social capital.

The paper develops a game theoretic model of the interaction of trust and the success of a group lending program. It aims to explain empirical findings that trust and social networks are important to the success of group lending schemes. In the model, individuals are randomly matched to play two repeated games simultaneously. They include a trust game and a microcredit game. Players are of two types, regular and trustworthy. Although player types are private information, reputations can be developed which support trust in the trust game and repayment in the microcredit game. The model shows that, under certain conditions:

• Trust can enhance the success of the group lending program;
• Success of the group lending program can enhance the development of trust.

Finally, threat of group default in the microcredit game, induced by the revelation of cheating in the trust game, may provide an incentive to sellers in the trust game to honor trust although they would cheat if the trust game were played in isolation.