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Joint-liability with endogenously asymmetric group loan contracts

Version 2 2024-06-04, 06:13
Version 1 2017-05-08, 19:14
journal contribution
posted on 2024-06-04, 06:13 authored by Francesco CarliFrancesco Carli, BR Uras
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.

History

Journal

Journal of development economics

Volume

127

Pagination

72-90

Location

Amsterdam, The Netherlands

ISSN

0304-3878

Language

eng

Publication classification

C Journal article, C1 Refereed article in a scholarly journal

Copyright notice

2017, Elsevier B.V.

Publisher

Elsevier

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