Joint-liability with endogenously asymmetric group loan contracts

Francesco Carli*, Burak R. Uras

*Corresponding author for this work

Research output: Contribution to journalArticleScientificpeer-review

Abstract

Group lending is a common practice that Microfinance Institutions (MFIs) utilize when lending to individuals without collateral. We develop a multi-agent principal-agent model with costly peer monitoring and solve for the optimal group loan contract. The optimal contract exhibits (i) a joint-liability scheme; and, (ii) asymmetric loan terms which can be interpreted as appointing a group leader, who has strong incentives to monitor her peer. Relaxing the joint-liability scheme implies the breakdown of equilibrium monitoring. When the contractual asymmetry is relaxed, the peer-monitoring game exhibits multiple Nash equilibria: a (weak) good equilibrium at which borrowers monitor each other and a (strong) bad equilibrium without monitoring. This key result suggests that profit maximizing MFIs should provide asymmetric group loan contracts - even to a homogeneous group of borrowers - to ensure stability in repayment rates.

Original languageEnglish
Pages (from-to)72-90
JournalJournal of Development Economics
Volume127
DOIs
Publication statusPublished - Jul 2017

Keywords

  • Microfinance
  • Joint-liability
  • Group leader

Cite this

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title = "Joint-liability with endogenously asymmetric group loan contracts",
abstract = "Group lending is a common practice that Microfinance Institutions (MFIs) utilize when lending to individuals without collateral. We develop a multi-agent principal-agent model with costly peer monitoring and solve for the optimal group loan contract. The optimal contract exhibits (i) a joint-liability scheme; and, (ii) asymmetric loan terms which can be interpreted as appointing a group leader, who has strong incentives to monitor her peer. Relaxing the joint-liability scheme implies the breakdown of equilibrium monitoring. When the contractual asymmetry is relaxed, the peer-monitoring game exhibits multiple Nash equilibria: a (weak) good equilibrium at which borrowers monitor each other and a (strong) bad equilibrium without monitoring. This key result suggests that profit maximizing MFIs should provide asymmetric group loan contracts - even to a homogeneous group of borrowers - to ensure stability in repayment rates.",
keywords = "Microfinance, Joint-liability, Group leader",
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Joint-liability with endogenously asymmetric group loan contracts. / Carli, Francesco; Uras, Burak R.

In: Journal of Development Economics, Vol. 127, 07.2017, p. 72-90.

Research output: Contribution to journalArticleScientificpeer-review

TY - JOUR

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AU - Carli, Francesco

AU - Uras, Burak R.

PY - 2017/7

Y1 - 2017/7

N2 - Group lending is a common practice that Microfinance Institutions (MFIs) utilize when lending to individuals without collateral. We develop a multi-agent principal-agent model with costly peer monitoring and solve for the optimal group loan contract. The optimal contract exhibits (i) a joint-liability scheme; and, (ii) asymmetric loan terms which can be interpreted as appointing a group leader, who has strong incentives to monitor her peer. Relaxing the joint-liability scheme implies the breakdown of equilibrium monitoring. When the contractual asymmetry is relaxed, the peer-monitoring game exhibits multiple Nash equilibria: a (weak) good equilibrium at which borrowers monitor each other and a (strong) bad equilibrium without monitoring. This key result suggests that profit maximizing MFIs should provide asymmetric group loan contracts - even to a homogeneous group of borrowers - to ensure stability in repayment rates.

AB - Group lending is a common practice that Microfinance Institutions (MFIs) utilize when lending to individuals without collateral. We develop a multi-agent principal-agent model with costly peer monitoring and solve for the optimal group loan contract. The optimal contract exhibits (i) a joint-liability scheme; and, (ii) asymmetric loan terms which can be interpreted as appointing a group leader, who has strong incentives to monitor her peer. Relaxing the joint-liability scheme implies the breakdown of equilibrium monitoring. When the contractual asymmetry is relaxed, the peer-monitoring game exhibits multiple Nash equilibria: a (weak) good equilibrium at which borrowers monitor each other and a (strong) bad equilibrium without monitoring. This key result suggests that profit maximizing MFIs should provide asymmetric group loan contracts - even to a homogeneous group of borrowers - to ensure stability in repayment rates.

KW - Microfinance

KW - Joint-liability

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U2 - 10.1016/j.jdeveco.2017.03.003

DO - 10.1016/j.jdeveco.2017.03.003

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JF - Journal of Development Economics

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