Monitoring by Delegates or by Peers? Joint Liability Loans Under Moral Hazard

This paper analyzes the experiences of the different procedures adopted by microfinance institutions (MFIs) to monitor the loan beneficiaries.

Presenting a strong case for joint liability loans in favor of individual loans, the paper examines:

• The conditions under which joint liability loans to encourage peer-monitoring can be offered and chosen, instead of monitored individual liability alternatives on a competitive loan market;
• The role that collusion may play in group loan design.

The paper states that it is not enough simply to create a joint liability contract to induce peer monitoring; the contract must also rely on a particular timing sequence and it requires commitment. There should be:

• Scheduling of regular group meetings;
• The use of periodic interim evaluations and monitoring reports;
• Contingent loan renewals over time;
• The practice of rotating loans amongst borrowers so that not all have a loan at the same time.

Finally, the paper highlights that joint liability contracts emerge as an optimal way to implement the Nash equilibrium model as it is a multi-agent, multi-task game, where each borrower is given incentives to remain diligent as a financed entrepreneur and to monitor others.