Borrower Empowerment and Savings: A Two-Stage Microfinance Scheme

The role of savings and borrower empowerment in microfinance
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This paper focuses on the linkage between microfinance and borrower (women) empowerment and the role of savings in microfinance. The paper examines a dynamic, two-stage microfinance lending scheme with moral hazard, endogenous group formation and joint-liability, where the provision of credit is conditional on prior savings, it examines the impact of such a scheme on the allocation of loans between strongly and weakly empowered borrowers. The authors find that:

  • As long as the borrowers are not too similar with respect to their level of empowerment, an increase in the prior savings requirement increases the incentive for homogenous group formation;
  • The savings requirement can be used as a tool to weed out weak borrowers;
  • For intermediate values of the rate of interest, group lending is feasible, while individual lending is not;
  • If the rate of interest is high, then individual lending may dominate group-lending.

The paper offers the following conclusions:

  • ‘Strong borrowers (S) have a greater chance of being empowered, in terms of control over household income;
  • Group formation leads to ‘positive assortative matching (PAM);
  • Savings requirement performs two roles:
    • It affects the incentive for SS-type group formation;
    • It can be used to screen out the weak borrowers.
  • As a policy tool, the savings pre-requisite needs to be used with care, since an increase in the savings requisite may lead to negative assortative matching.

About this Publication

By Chowdhury, P.