Social Connections and Group Banking

A study of the link between social connections and loan repayments
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This paper examines whether groups that are more connected socially perform better in the area of loan repayment. The author argues that stronger social connections within the group lead to improved ex-post repayment and savings behavior by the clients.The author collected data from FINCA-Peru, a group-lending organization, to investigate whether geographical and cultural connections make peers more likely to both repay their loans and save more. He:

  • Describes FINCA's methodology of quasi-random group selection;
  • Finds that individuals who live closer to one another and are more culturally similar to others in the group are more likely to repay their loans and save more;
  • Presents evidence of monitoring, such as knowledge of each others default status, as well as direct evidence of punishment, such as deterioration of relationships;
  • Finds evidence that better-connected individuals are more likely to be forgiven for defaulting.

The paper discusses:

  • Joint liability mechanisms and FINCA-Peru;
  • The survey procedures and the data collected;
  • The identification strategy employed in the analysis;
  • The results on the lending and savings outcomes;
  • Direct observations of monitoring and enforcement activities.

The paper concludes that:

  • Monitoring and enforcement activities do improve group lending outcomes;
  • Social connections facilitate the enforcement of joint liability loan contracts;
  • Cultural similarity and geographic concentration lead to improved group lending outcomes;
  • Non-market institutions and forces can help overcome market failures.