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Group Lending Microfinance. Lecture # 5 Week 3. Structure of this class. Description of “the classic” GLJR contract Overcoming adverse selection Overcoming moral hazard Evidence Limitation of the GLJR contracts. Description of the GLJR contract. Some background

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Group Lending Microfinance

Lecture # 5

Week 3


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Structure of this class

  • Description of “the classic” GLJR contract

  • Overcoming adverse selection

  • Overcoming moral hazard

  • Evidence

  • Limitation of the GLJR contracts


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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


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Like ROSCAs and Credit CooperativesEarly microfinance institutions involved groupsEach participant borrower responsible for the debt of othersLoans are granted individuallyIf entire group’s debt is not repaid, all individuals are excluded from future refinancingCommon 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 linksDelegation of agency problems due to asymmetric information from microfinance lenders to the borrowers   efficiency


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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


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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



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Some evidence

  • BRAC

  • VO

  • Finca

  • ProMujer

  • Lab Experiments


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Some Limitations

Next class: A-M Chapter 5


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