Joint Liability Lending in Microcredit Markets with Adverse Selection: A Survey
This paper discusses lending methodology as under:
- The individual lending methodology with no collateral:
- It considers a market characterized by adverse selection. The market consists of risky and safe borrowers with risky borrowers having lower probability of repayment with high returns;
- It argues that although both types of borrowers are socially profitable, only risky borrowers receive funding in case of individual lending;
- This leads to higher break-even interest rates for micro-lender leading to under investment.
- The joint liability lending:
- It argues that joint liability lending helps an institution in separating risky borrowers from safe borrowers;
- As a result, both repayment rates and social welfare are higher when compared to individual lending as safe borrowers also apply for loans.
The paper concludes that the joint liability lending overcomes the problem of lack of collateral under joint liability:
- Safe borrowers will select the contract with higher joint liability and lower interest rates;
- Risky borrowers will select the contract with lower joint liability and higher interest rates.
The paper concludes that the repayment rate and welfare rise under joint liability when compared to individual liability, as joint liability is able to exploit the information with borrowers.