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Efficient Microlending without Joint Liability

By Ahmet Altınok and Can Sever

Abstract

Peer-group mechanisms have been widely used by micro-credit institutions to minimize default risk. However, there are costs associated with establishing and maintaining liability groups. In the case when output is fully observable, we propose a dynamic individual lending mechanism. Assuming that risky borrowers discount the future costs and benefits relatively higher, our mechanism performs equally well in repayment rates, distinguishes safe and risky borrowers through differentiated interest rates and payment schedules. In case of unobservable types, it is able to eliminate adverse selection problem, and it reaches the first best outcome of the case that types of borrowers are publicly known. It improves wealth of individuals, and hence achieves a net welfare-superior outcome when compared with joint liability. Individual lending further saves from internal costs of group formation, and broadens the fractions of society into which microfinance institutions penetrate. We also identify unique welfare maximizing contract in our mechanism. Finally, we introduce a history dependent success probabilities, and show existence of efficient individual contract in that environment.

Topics: D60 - General, D86 - Economics of Contract: Theory, G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages, O1 - Economic Development, O12 - Microeconomic Analyses of Economic Development
Year: 2014
OAI identifier: oai:mpra.ub.uni-muenchen.de:56598

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