Group Lending Under Dynamic Incentives as a Borrower Discipline Device

This paper uses empirical results from field research on Guatemalan borrowing groups to develop a game-theoretic model of group lending.

The model portrays a borrowing group as a kind of evolving jury or a dynamic peer review committee. In an imperfect-information framework, the model illustrates how:

• Informational flows, dynamic repayment incentives, group pressure, intra-group insurance and social relationships work together to mitigate asymmetric information problems;
• Potential for intra-group credit insurance and the threat of being expelled from the group deters borrowers from misallocating borrowed capital;
• Credible threat of social sanctions further reduces instances of risky investment behavior;
• Trade-off exists between the credible threat of social sanctions and peer monitoring;
• Social sanctions compensate for poor informational flows in contexts where direct peer monitoring is difficult.

The paper suggests that much of the borrower screening actually occurs ex post to group formation, in the form of group expulsions. It indicates that members self-select under imperfect information, come to the aid of other members who appear victims of unavoidable shocks, and expel those likely to have misallocated their borrowed capital.