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Group lendingprimer
 

Group lendingprimer

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    Group lendingprimer Group lendingprimer Presentation Transcript

    • The Economics of Group Lending This is completely based on The Economics of Microfinance (2005) Beatriz Armend á riz de Aghion & Jonathan Morduch The MIT Press, Cambridge, Massachusetts
    • The Principal-Agent Relationship
      • PRINCIPAL [Uninformed]
      • AGENT [Informed] view of “contracts”
      • Moral Hazard: Fire insurance example
      • Adverse Selection: Health insurance example
    • Understanding Credit Using the Principal-Agent Relationship
      • The Principal is
      • The MFI
      • The Agent is
      • The Borrower
      • The MFI can choose individual or group lending technologies
    • Basic Assumptions: “No-fat” model
      • Assume MFI is in a competitive market: Would like to charge an interest rate that covers cost of funds, operating expenses and possible default
      • Borrower either Safe Type [invests in Month 0 in specific project and earns income with certainty in Month 1]
      • OR
      • Risky Type [invests in Month 0 in specific project and either earns a higher income than Safe in Month 1 or earns zero income
      • Unless otherwise explicitly assumed, borrowers have no collateral–loan repayment [principal+interest] has to be made out of income from the specific project]
    • ADVERSE SELECTION Illustration 1.1: Individual Lending
      • IF
        • An MFI faces a potential client group that includes both Safe and Risky borrowers
        • Cannot distinguish between them
        • And wishes to sanction individual loans
      • THEN
      • The MFI will have to increase its interest rate to take care of possible defaults by Risky borrowers. The interest rate will depend on:
        • The fraction of Safe borrowers
        • The probability that Risky borrower is successful
    • ADVERSE SELECTION Illustration 1.1: Individual Lending-Sensitivity
      • Fraction of Safe borrowers in the population 40%
      • Probability that a Risky borrower is successful 50%
    • ADVERSE SELECTION Illustration 1.2: Individual Lending
      • IF
        • An MFI faces a potential client group that includes both Safe and Risky borrowers
        • Cannot distinguish between them
        • And wishes to sanction individual loans
      • THEN
      • The interest rate the MFI has to charge may become so high that Safe borrowers no longer wish to borrow, and the MFI is left with only Risky borrowers
    • ADVERSE SELECTION Illustration 1.2: Individual Lending-Sensitivity
      • Risky Borrower: Gross revenue if successful 267
      • AND Probability of success 75%
    • ADVERSE SELECTION Illustration 1.3: Group Lending
      • IF
        • An MFI allows potential borrowers to form groups with joint liability
        • The bank offers all groups the same interest rate
        • AND potential borrowers know each other’s type [Safe OR Risky]
      • THEN
        • Borrowers sort themselves into groups: The Safe partner with other Safe and the Risky with other Risky
        • Also although the bank charges all groups the same interest rate, the Risky end up paying more than the Safe [a well-deserved fate]
    • EX ANTE MORAL HAZARD Illustration 2.1: Individual Lending-Without Collateral
      • IF
        • An MFI has lent money to an individual without collateral
        • The borrower can choose
          • To expend effort and earn an income with certainty
          • Or “slack” and either earn a positive income or earn zero
      • THEN
        • Beyond a certain interest rate the borrower will choose NOT to expend effort but to slack
        • If this interest rate is less than the rate that covers the MFI’s cost, the MFI may find it optimal NOT to lend
    • EX ANTE MORAL HAZARD Illustration 2.1: Individual Lending-Without Collateral -Sensitivity
      • Cost to borrower of effort 0.30
      • Profit to borrower with effort 2.0
      • Probability of positive profit without effort 80%
    • EX ANTE MORAL HAZARD Illustration 2.2: Individual Lending-With Collateral
      • IF
        • An MFI has lent money to an individual with collateral
        • The borrower can choose
          • To expend effort and earn an income with certainty
          • Or “slack” and either earn a positive income or earn zero
      • THEN
        • Even if the MFI charges a higher interest rate than in Illustration 2.1, the borrower may choose to expend effort
    • EX ANTE MORAL HAZARD Illustration 2.2: Individual Lending-With Collateral-Sensitivity
      • Borrower's collateral 50%
    • EX ANTE MORAL HAZARD Illustration 2.3: Group Lending
      • IF
        • An MFI has lent money to individuals who are members of a group with joint liability
        • Each borrower can choose
          • To expend effort and earn a certain income
          • Or “slack” and either earn a positive income or earn zero
      • THEN
        • Even if the MFI charges a higher interest rate than in Illustration 2.2, the borrowers may choose to expend effort
        • More importantly, the borrowers may not “slack” at all
    • EX POST MORAL HAZARD Illustration 3.1: Individual Lending with Possible Collateral
      • IF
        • An MFI has lent money to an individual with possible collateral [less than the total repayment of principal+interest]
        • The borrower invests in a successful project that earns income with certainty
        • The borrower can choose either to repay or default
        • The collateral is seized if the default is detected by the MFI
      • THEN
        • Then the borrower will default if the interest rate is set too high
        • The MFI may decide not to lend
    • EX POST MORAL HAZARD Illustration 3.1: Individual Lending with Possible Collateral-Sensitivity
      • Borrower's collateral 140%
    • EX POST MORAL HAZARD Illustration 3.2: Group Lending
      • IF
        • An MFI has lent money to individuals who are members of a group with joint liability
        • A group member can monitor peer at a cost, possibly observe the actual income of peer and apply “sanctions” if borrower tries to default
      • THEN
        • The threat of sanctions may reduce default depending on
          • The monitoring cost
          • The probability of observing actual income of peer
          • The value of social sanctions imposed on defaulter