The Distributional Implications of Group Lending

Understanding links between contractual structure, credit outreach and borrower welfare
Download 22 pages

This paper examines the role of joint liability in increasing borrower welfare and providing the poor with access to credit.

Doubts about the value of joint liability in expanding credit outreach have led to several MFIs shifting from group loans to individual contracts with members of groups. The paper focuses on the ex-post moral hazard problem of repaying a loan on completion of a successful project. Study results indicate that:

  • In the absence of social sanctions, the largest available loans are offered under individual contracts;
  • Joint liability per se cannot bring credit to the doorstep of those not currently served by the banking system;
  • Social sanctions within groups depend upon project uncertainty and can, at best, substitute for bank sanctions;
  • Groups with the highest initial endowment of wealth reap the greatest welfare gains.

The paper demonstrates that joint liability can increase borrower welfare, but its ability to provide the poor access to credit is often limited. The poorest households are likely to be best served when they can avail of individual loans on more favorable terms and through promotion of alternative poverty alleviation programs.