1. Group Lending Microfinance
Lecture # 5
Week 3

2. Structure of this class
Description of “the classic” GLJR contract
Overcoming adverse selection
Overcoming moral hazard
Evidence
Limitation of the GLJR contracts

3. Description of the GLJR contract
Some background
First experiments in Jobra near Chittnagong University. Loans made to individuals
M. Yunus and associates soon realized that extending loans to groups had the following advantages: economies of scale, and saving in screening, monitoring and enforcing

4. Like ROSCAs and Credit Cooperatives Early microfinance institutions involved groups Each participant borrower responsible for the debt of others Loans are granted individually If entire group’s debt is not repaid, all individuals are excluded from future refinancing Common wisdom: incidence of default is reduced because participant borrowers are in a relatively superior position to screen, monitor and enforce repayments due to geographical proximity and other links Delegation of agency problems due to asymmetric information from microfinance lenders to the borrowers   efficiency

5. Overcoming Adverse Selection
Assume:
Each individual has a one-period project requiring $1 investment
There are two types of borrowers: “safe” and “risky”
Fraction of the population that is safe is q<1, and risky 1-q
A dollar invested by a safe borrower yields y with certainty and a
a dollar invested by a risky borrower yields
with probability p
There will be assortative matching (s,s) and (r, r) and:
where g is the probability of luck in a risky pair

6. And the break even rate:
Which is smaller than the break even rate in the absence of GLJR
Intuition: the risky types can repay back their loans more often thanks to GLJR.
Risk passed on from bank to risky borrowers
Interest rates can be reduced
Deserving safe types back into the market

7. Overcoming Ex Ante Moral Hazard

11. Some evidence
BRAC VO
Finca
ProMujer
Lab Experiments

12. Some Limitations
Next class: A-M Chapter 5