Empirical Analysis of the Mechanisms of Group Lending

This study examines how joint liability works in practice, by interviewing clients of the microfinance institutions (MFIs), ASA Grama Vidiyal and CASHPOR Microcredit (CMC), in two states of India. The study:

• Presents findings in relation to literature on the topic of joint liability;
• Examines how groups screen their members, monitor behavior and investments and enforce repayment;
• Identifies areas where MFIs can improve client impact and efficiency through institutional, policy or product design innovations.

It presents the following findings:

• Clients select each other according to geographical location;
• When MFIs intervene in the group selection process, the joint liability mechanism often breaks down;
• Interviewees know the other members and their activities before group formation;
• Explicit screening behavior through home visits takes place when the group has to replace original members;
• The group scrutinizes the size of the loan;
• Members interact during group meeting and visit each others businesses to monitor activity;
• Regarding repayment, groups help out members or exert pressure on them;
• External shocks cause default rather than bad business;
• Loan sizes remain the same through cycles and are relatively uniform within the group.

The study concludes that:

• Institutional, policy and product design features influence client borrowing behavior;
• Experimentation with alternative methods could improve monitoring, screening and enforcing mechanisms.