Group Size and Social Ties in Microfinance Institutions

This paper investigates the effects of group size and social ties on lending in microfinance institutions (MFIs). It states that in "Group lending":

• Borrowers with individual risky projects form groups that apply for loans together;
• Individual borrowers rely on fellow borrowers to repay the loans.

To safe guard against this, MFIs have introduced schemes where the borrowerss groups are self-selected. The expectation here is that:

• Close social ties enhance peer pressure and group solidarity;
• Dynamic incentive schemes, such as, follow-up loans being made conditional to the repayment of previous loans, could be implemented.

The authors claim to introduce an alternative approach to the empirical analysis of MFIs. The experiment has the following features:

• It has a stylized MFI scenario;
• Repayment depends on group solidarity alone;
• Follow-up loans are subject to full repayment in the past;
• It focuses on three instrumental variables identified as crucial for MFI success:
  • The group size;
  • The dynamic incentive structure;
  • The intensity of social ties between group members.

The authors observed the following results of the experiment:

• Robust performance, with higher repayment rates than in individual lending;
• Importance of dynamic incentives;
• Moderate effect of social ties on repayment rates;
• Women contributing more than men.

The paper concludes that the experimental method is well suited to finding out how and why group lending schemes succeed or fail in practice.