Ex-ante Moral Hazard and Repayment Performance under Group Lending

This paper investigates whether group lending has the information advantage of overcoming ex-ante moral hazard and the efficiency advantage of improving repayment performance, when compared to individual liability lending.

The paper attempts to contribute to ex-ante moral hazard literature by formalizing the dynamic incentive of non-refinancing threat. It assumes that such a threat affects borrowers' efforts and repayment performance under group lending and individual liability lending.

The paper constructs a simple dynamic model in an environment characterized by ex-ante moral hazard and lack of collateral. The results of the model reveal that:

• When group members make effort decisions non-cooperatively, individual equilibrium effort under group lending is lower than that under individual liability lending;
• Mere joint liability and non-refinancing threat cannot mitigate ex-ante moral hazard;
• When group members coordinate their effort choices, the analytical result of the comparison in individual equilibrium effort between individual liability lending and group lending depend on certain conditions;
• Group lending without peer cooperation achieves the same performance as individual liability lending;
• Group lending with peer cooperation outperforms individual liability lending in encouraging repayment.