Collateral and Risk Sharing in Group Lending: Evidence from an Urban Microcredit Program

This paper explores the role of collaterals to mitigate problems in group lending, in an urban setting. It suggests that it is important to know the possible role of collateral to mitigate incentive problems, as information in urban settings is more atomized and social sanctions not as powerful as in rural settings.

The paper uses data from a group lending program implemented in 2001 in Cotonou, the largest city in Benin, to demonstrate the role of collateral to mitigate group default. It empirically explores the risk profile of individual borrowers and resulting group heterogeneity to identify the role of personal contributions to investment projects. The paper also notes that:

• While diversification within groups facilitates risk pooling, it also increases expected bailout or group default costs for low risk borrowers;
• Collaterals help offset and alleviate potential negative spillovers from group default, induced by membership of borrowers with risky projects; and
• Presence of borrowers with collateral facilitates access to credit for group members without collateral, who in turn provide insurance against group default.