Social Collateral solution to the problems 1.“How can I get credit if I have no collateral” 2.“How can I grow larger when I can’t get a loan because my business is too small?” 3.“The success of each store depends on the success of every store on Main Street.” ?

Social Collateral Approach: Peer Group of Borrowers  Collateral individual finds others to co-sign or guarantee banker must screen diversification is banker responsibility banker monitors borrower for repayment Social Collateral approach: Traditional credit approach: small borrowers self-select into group information diversification peer pressure ensures repayment

Grameen Bank Founded by Professor Mohammed Yunus in 1976 Dr. Yunus is the winner of the 1994 World Food Prize The largest rural finance institution in Bangladesh 1,128 branches 38,951 villages >2.3 million 94% women Loan size 7,200T (relative to US income/cap = $3,500) Default Rate < 2% Interest rate higher than market rate

Key Features of Group Lending 1.PEER PRESSURE 2. INFORMATION TRANSFER 3. MUTUAL INSURANCE 4. COOPERATION

PEER PRESSURE Joint liability: every member of the peer group is in default if any member is. If peers can/will impose social penalties on each other, this adds an additional incentive not to default on one’s portion. => reduces moral hazard  reduces the riskiness of the loans  increases likelihood of obtaining the loan

INFORMATION TRANSFER Borrowers self-select into groups with people they know and trust.  reduces incidence of adverse selection  new or low income entrepreneurs more welcome  increased value of the group loan as an asset (to the lender)

MUTUAL INSURANCE The group is a safety net against default and its consequences for each borrower and the lender. Members effectively insure each other across project-specific downside risks. => Less credit risk. =>Applications rates rise. => Loan approval rates can rise.

COOPERATION Cooperation allows for bundling of too small loans into one reasonable size loan. Cooperation = coordination to simultaneously open the right mix of interdependent businesses.  enhances lending efficiency  enhances value of pre-existing collateral  borrower group is self-diversified

Peer Group Micro Lending in USA Women’s Self-Employment 1986Chicago Good Faith Fund1988rural Arkansas NC Micro-enterprise Loan 1989North Carolina FINCA-USA1994HQ: WDC

totalloansavg amtidefault training group Women’s Self Emp $1.3m1,000+$1-$10K< 5%  5 Good Faith Fund $.5m25/yr$1.2-$5Kmkt (?)40 -3%  5-7 NC MicroEnt Loan Progr $51m58/yr$1.5-$8K12-16%4%  5 FINCA-USA200$0.5-$6K12%6%  4

GRAMEEN BANKCONVENTIONAL U.S. BANKS PEER GROUP PEER GROUP MICROLENDING IN THE U.S. avg loan amount 7,200T ($3,500)13% <$10K$1-$10K collateralsocial real property required 72% time interest rate above marketmktabove market borrower group co-signers, guarantors, partners 5 default rate 2%5% self-selectionyes not exactly

Grameen  Micro Lending in USA Grameen principle: 1.bottom-up 2.bank is financially self-contained 3.group members have prior relationships 4.group will impose social sanctions on each other 5.borrowers in one group undertake diverse projects 6.social collateral = mutual insurance USA Micro Lending : 1.top- down 2.donations and grants are major source of funds 3.group members previously strangers 4.members will not impose on each other 5.projects not mixed /selected 6. group activities are required- to deter frivolous borrowers

LESSONS FROM USA EXPERIENCE The overall success of peer group microlending programs in the United States and Canada has not matched the success of many of the programs abroad. While the number of such programs in North America has increased, many programs have also failed and terminated. One possible reason for the limited success of current programs is that they do not realize the advantages of group self-selection, information transfer, peer-monitoring, peer pressure, mutual insurance and the other benefits from social collateral that the Grameen Bank participants enjoy.

Social Collateral solutions to the problems: 1.“How can I get credit if I have no collateral” Join a borrower group and offer “social collateral/mutual insurance” instead. 2.“How can I grow larger when I can’t get a loan because my business is too small?” Join a borrower group and bundle many members “too small” credit needs into one larger loan. 3.“The success of each store depends on the success of every store on Main Street.” Form a borrower group that promises to simultaneously open the critical mass of interdependent diverse local businesses.