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Efficient Microlending without Joint Liability

Ahmet Altinok and Can Sever

MPRA Paper from University Library of Munich, Germany

Abstract: Peer-group mechanisms have been widely used by micro-credit institutions to minimize default risk. However, there are costs associated with establishing and maintaining liability groups. In the case when output is fully observable, we propose a dynamic individual lending mechanism. Assuming that risky borrowers discount the future costs and benefits relatively higher, our mechanism performs equally well in repayment rates, distinguishes safe and risky borrowers through differentiated interest rates and payment schedules. In case of unobservable types, it is able to eliminate adverse selection problem, and it reaches the first best outcome of the case that types of borrowers are publicly known. It improves wealth of individuals, and hence achieves a net welfare-superior outcome when compared with joint liability. Individual lending further saves from internal costs of group formation, and broadens the fractions of society into which microfinance institutions penetrate. We also identify unique welfare maximizing contract in our mechanism. Finally, we introduce a history dependent success probabilities, and show existence of efficient individual contract in that environment.

Keywords: Microfinance; Graamen bank; joint liability; adverse selection; microlending; group lending; individual lending (search for similar items in EconPapers)
JEL-codes: D60 D86 G21 O1 O12 (search for similar items in EconPapers)
Date: 2014-05-11
New Economics Papers: this item is included in nep-ban, nep-cta, nep-law and nep-mfd
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