2.2 The Problem of Asymmetric Information in Credit Markets
2.3.1 Information Processing and Screening Mechanisms
2.3.3.3 Joint Liability Groups
This collateral substitute has been used successfully by MFOs such as the Grameen Bank in Bangladesh and BancoSol in Bolivia. Rural borrowers are required to form small, socially cohesive groups, such that group members are jointly responsible for each other's debt obligations. Hence, group members are expected to exert considerable peer pressure to ensure that all members' loans are repaid, since no member of a group can access additional credit until all members of the group have repaid their loans (paxton et al.., 2000). Rigorous application of this rule is required for the joint liability mechanism to be effective. This also provides the necessary incentive for groups to effectively screen members and monitor each other. Where groups have been larger, group leaders have been required to pledge personal assets as collateral to ensure contract enforcement (Desai, 1983; Graham and von Pischke, 1994).
Given that individual group members have to screen and monitor each other, joint liability groups have been observed to work best when they are small (four to six members) and homogenous with respect to social and economic criteria (Jain, 1995). High population
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densities in the villages of Bangladesh, Thailand and Bolivia result in close proximity for group members such that peer monitoring is feasible. The joint liability mechanism has been less effective for larger groups, particularly in African agricultural group-lending programmes, where group members tend to be spatially disbursed, heterogeneous and where male group members migrate to towns to fmd employment (Graham, 1995a).
Group lending also requires considerable inves,tments in group formation (such as fmding members, training and setting up governance structures), which may be borne by both borrower and lender (paxton et al.., 2000). This often results in high transaction costs for borrowers and lenders, negatively affecting group solidarity while also increasing lender administration costs. In addition, well trained and committed staff are required to administer these programmes that may impose additional costs on lenders. The Grameen Bank has invested heavily in group formation which has negatively affected financial viability but contributed to the success of the group lending programme. The Grameen Bank: has also been able to recruit highly qualified lending staff without having to pay high salaries - this has saved on overhead costs. African programmes in Malawi and Burkina Faso have shown lower levels of investment in group formation, partly contributing to their poor performance (Graham and von Pischke, 1994; Graham, 1995a).
Successful groups have frequent repayment schedules (weekly or bi-weekly) to provide the regular interaction between group members and lenders that is required to maintain group cohesion. This does not suit the seasonal cash flow patterns of agriculture, and groups consisting only of farmers have encountered difficulty in maintaining group solidarity. Group lending programmes built on micro-enterprise activities with more regular cash flows have been more successful (Yaron, 1994; Paxtonet al.., 2000).
The joint liability concept also has its limits. Graham and von Pischke (1994) and Gonzalez- Vegaet al. (1997) argue that this mechanism does not necessarily guarantee loan repaYment since the incentives that it creates have ambiguous impacts on group members' willingness to repay. Firstly, non-defaulting members undertake repaYment for defaulting members or encourage delinquent members to pay their loan to avoid the loss of their own reputation with the lender. Evidence suggests that once individuals in a group have covered the shortfall of delinquent group members two or three times, the group collapses, resulting in total default Goint enforcement creates hostility within the group). This has frequently been observed in African group lending programmes (Graham and von Pischke, 1994). To avoid hostility within groups, group members are often required to contribute to a compulsory savings fund from which money can be taken to make up the shortfall of delinquent members. However, contributions to such funds tend to be small and cannot sustain continued default by group members.
Secondly, default by some members may prompt default by other members if the costs of repaying the defaulters' loans are higher than the value of the individual's relationship with the lender (Besley and Coate, 1995). This may be the case where individuals in the group have easy access to alternate sources of credit, and where lenders do not strictly enforce the rule of not granting individuals access to future credit if current loans are not repaid. Group loans also present borrowers with particular contract rigidities which include the need for synchronous terms to maturity and repaYment schedules, and having to participate in group meetings which may further reduce the perceived benefits of this type of credit to group members, particularly over time (Gonzalez-Vegaet al., 1997; Paxtonet al.., 2000).
Gonzalez-Vega et al.. (1997) have argued that since individuals in BancoSol's group lending programme do not have access to alternate sources of credit, the value of the client-lender relationship has been sufficiently enhanced to promote loan repayment, rather than the joint liability mechanism itself. Joint liability groups may thus be an effective collateral substitute, but replicability of this form of collateral requires careful consideration of the social setting of the target clientele and of the requirements for successful implementation of this technology.