Social collateral,dynamic incentives,and joint liability in a two‐step trust game: Lending to the unbankable

Asymmetric information and lack of collateral creates a suboptimal allocation of financial resources to those in most need. When uncollateralised borrowers approach financial institutions, the presence of moral hazard and adverse selection results in no lending. Conversely, group‐lending contracts—joint liability, dynamic lending, and social cost for defaulting—control for information asymmetries and create a co‐operative trust game between borrowers leading to an undominated optimal strategy to repay, and therefore, for the lender to Give. Group lending proves superior to typical individual borrowing and lending when no collateral is available. Social collateral and trust are fundamental pieces of the successful work of MicroFinance. Resulting contracts and correspondent payoffs are Pareto efficient.     

Is it better to be mixed in group lending?

This paper shows that, in a group‐lending scheme with joint liability, a microfinance institution can achieve a Pareto improvement by promoting negative assortative matching among borrowers. The main results are: (i) borrowers may be better off in heterogeneous groups; and (ii) a heterogeneous group equilibrium is possible when individual or homogeneous group equilibria do not exist.     

Monetary and Financial Integration in the EMU: Push or Pull?

This paper examines the channels through which monetary union increased financial integration, using panel data on bilateral international commercial bank claims from 1998–2006. I decompose the increase in claims into three channels: a "borrower effect," as a country's EMU membership may leave its borrowers more creditworthy in the eyes of foreign lenders; a "creditor effect," as membership in a monetary union may increase the attractiveness of a nation's commercial banks as intermediaries, perhaps through increased scale economies or through an improved regulatory environment after the advent of monetary union; and a "pairwise effect," as joint membership in a monetary union increases the quality of intermediation between borrowers and creditors when both are in the union. Isolating these three channels through a series of difference-in-differences specifications, I find that the pairwise effect is the primary source of increased financial integration. This result is robust to a number of sensitivity exercises.     

Microfinance Beyond Group Lending

Microlending is growing in Eastern Europe, Russia and China as a flexible means of widening access to financial services, both to help alleviate poverty and to encourage private-sector activity. We describe mechanisms that allow these programmes to successfully penetrate new segments of credit markets. These features include direct monitoring, regular repayment schedules, and the use of non-refinancing threats. These mechanisms allow the programmes to generate high repayment rates from low-income borrowers without requiring collateral and without using group lending contracts that feature joint liability.     

Adverse selection as an explanation of credit rationing and different lender types

An adverse selection model is utilized to demonstrate that informational asymmetry may make it wealth optimal for the financial intermediary (FI) to credit ration and to rationalize the existence of different lenders in the credit market. The crucial assumption is that borrowers differ in their tolerance for a lender-imposed default penalty, the severity of which also varies with the lender. The credit rationing portion proves that the FI will: 1) be forced by a binding regulatory constraint to overinvest in capital; 2) ration its worst risk class borrowers; 3) establish its optimal loan interest rate on the basis of the average quality of its loans and the interest rate elasticity of the borrower demand in its best risk category; and 4) decrease the total loan volume and increase the loan interest rate due to an increase in the capital requirement, but the effect on the default risk quality of its loan portfolio is ambiguous. The existence result is that if a lender has a high default penalty, he can charge a lower rate and attract only “good” borrowers, i.e., heterogeneous lender types encourage the screening of borrowers and vice versa.     

Group-lending: Sequential financing,lender monitoring and joint liability

We develop a simple model of group-lending based on peer monitoring and moral hazard. We find that, in the absence of sequential financing or lender monitoring, group-lending schemes may involve under-monitoring with the borrowers investing in undesirable projects. Moreover, under certain parameter configurations, group-lending schemes involving either sequential financing, or a combination of lender monitoring and joint liability are feasible. In fact, group-lending schemes with sequential financing may succeed even in the absence of joint liability, though the repayment rate will be lower. In the absence of joint liability, however, group-lending with lender monitoring is unlikely to be feasible.     

Strategic default and optimal audit resources with costly state verification

I develop a model in which the ability to repay a loan is private information that can only be verified by the bank at some costs, which can be recovered from the borrower if it has reported untruthfully. The bank will optimize the resources it spends on this auditing of borrowers and the resulting equilibrium is then characterized. It is shown that in equilibrium, a significant fraction of companies default strategically, but most are captured via auditing. The failure rates of banks are also small. Finally extensions are discussed to include limited liability to banks and the partial recovery of auditing costs as well as punitive costs to borrowers.     

North–South Lending with Moral Hazard and Repudiation Risk

The paper shows that the joint presence of moral hazard and repudiation risk generates an important interaction effect. In order to provide the proper incentives to borrowers, the optimal financial contract under moral hazard calls for all available resources to be paid to the lender in the event of a poor realization for output. Repudiation risk limits the size of this transfer, as the debtor has the option to default. This upper bound on the resource transfer exacerbates the moral hazard problem, reducing lending and the equilibrium level of investment and output.     

Convergence Clubs: Some Additional Evidence

The paper shows that the joint presence of moral hazard and repudiation risk generates an important interaction effect. In order to provide the proper incentives to borrowers, the optimal financial contract under moral hazard calls for all available resources to be paid to the lender in the event of a poor realization for output. Repudiation risk limits the size of this transfer, as the debtor has the option to default. This upper bound on the resource transfer exacerbates the moral hazard problem, reducing lending and the equilibrium level of investment and output.     

Endogenous growth and the emergence of equity finance

This paper characterises the development of equity markets as a dynamic process that both influences and is influenced by the development of the real sector of the economy. In overlapping generations, economy borrowers seek funds to run risky investment projects by drawing up contracts which may take the form of either equity or debt issue. In the presence of information asymmetry between borrowers and lenders, the optimal contract is determined by trading off information dilution costs against bankruptcy costs. Significantly, the equilibrium choice of contract depends on the state of the economy which, in turn, depends on the contracting regime. Based on this analysis, the paper provides a theory of the joint determination of real and financial development with the ability to explain the emergence of a stock market along the path of real development.     

Screening by the Company You Keep: Joint Liability Lending and the Peer Selection Effect

We look at an economic environment where borrowers have some information about the nature of each other's projects that lenders do not. We show that joint-liability lending contracts, similar to those used by credit cooperatives and group-lending schemes, will induce endogenous peer selection in the formation of groups in a way that the instrument of joint liability can be used as a screening device to exploit this local information. This can improve welfare and repayment rates if standard screening instruments such as collateral are unavailable.     

Dual Financial Systems and Inequalities in Economic Development

This paper analyzes the emergence and the evolution of a modern banking system, in a developing economy where banks coexist with informal credit institutions. Banks have a superior ability in mobilizing savings while informal lenders enjoy a superior information on borrowers. More specifically, banks cannot observe perfectly the behavior of borrowers; therefore the latter need to provide collateral assets in order to obtain bank loans. Physical collateral is not needed to borrow in the informal credit market: informal lenders can rely on social networks to obtain information on borrowers' behavior and invoke social sanctions to enforce repayment. The sustained growth path is associated with the successful development of the banking system that gathers savings on a large scale. However, informal lenders and other traditional credit institutions are necessary in the first stage of development when collateral is scarce. In this economy, the development of modern financial intermediaries is closely associated with the accumulation of collateral assets by entrepreneurs. This implies that the initial level of development as well as the initial distribution of wealth will determine the joint evolution of the real side of the economy and the financial system. Under certain conditions, two long-run steady-state equilibria exist: in the first one the economy stops growing and the banking system never successfully develops; in the second one the economy reaches a sustained growth rate and the informal sector asymptotically vanishes. The impact of the following policies is discussed: financial repression, micro-credit institutions and redistribution of assets.     

Group insurance and lending with endogenous social collateral

We construct a dynamic model of self-enforcing insurance provision and lending to a community of borrowers who are connected by risk-sharing arrangements that are themselves subject to enforcement problems, as in Kocherlakota (1996). We show that an outside lender offering constant-consumption contracts can earn a higher profit if he conditions his repeated interactions with each borrower on the history of his interactions with all the group members (a joint liability contract), rather than on his history with that borrower only (individual liability contracts). This result holds even in the absence of informational asymmetries. The observation driving it is that with individual liability contracts, a joint welfare-maximizing group may prefer to have one or more group members default on their contracts, so that the group can consume a mix of outside funds and the defaulters' stochastic income. One contribution of our work is to give precise economic content to the concept of “social collateral” as the per-agent surplus from group risk-sharing over autarky. The group can deter its members from defaulting on their contracts with the principal by threatening to reduce that surplus.     

Do women borrowers augment financial performance of MFIs?

There is some consensus that depth of outreach and financial performance of Microfinance Institutions (MFI) are positively correlated. A majority of microcredit borrowers are women and since the prevalence of female borrowers is even greater among the very poor, there should be a positive correlation between female borrowers and financial performance. Most of the MFIs target women as preferred borrowers. However, no study to date has investigated the relationship between targeting women and MFI’s sustainability with respect to profitability and yield. Utilizing a panel of 892 MFIs over a period of 10 years, this study shows that increased proportion of women borrowers has a statistically significant positive impact on yield and financial performance of MFIs. Consequently, this article also analyses the implication as to whether female borrowers have better repayment rate than male borrowers.     

Collusion and group lending with adverse selection

In an environment with correlated returns, this paper characterizes optimal lending contracts when the bank faces adverse selection and borrowers have limited liability. Group lending contracts are shown to be dominated by revelation mechanisms which do not use the ex post observability of the partners' performances. However, when collusion between borrowers under complete information is allowed, group lending contracts are optimal in the class of simple revelation mechanisms (which elicit only the borrower's own private information) and remain useful with extended revelation mechanisms.     

Vertical Links Between Formal and Informal Financial Institutions

The paper investigates vertical linkages between formal and informal financial institutions. Specifically, it studies a policy that expands formal credit to informal lenders, in the hope that this will improve loan terms for borrowers who are shut out of the formal sector. Special attention is paid to the Philippines. It is argued that the effects of stronger vertical links depend on the form of lender competition. In particular, if the relationship between lenders is one of strategic cooperation (sustained by threats of reprisal in a repeated setting), an expansion of formal credit may worsen the terms faced by informal borrowers.     

Long-run Growth and Intragenerational Transfer Under Capital Market Imperfections

The purpose of this paper is to provide a long-run growth model linking growth to income distribution between lenders and borrowers in an environment where enforcement of loan contracts is imperfect. The equilibrium under costly verification implies a smaller growth rate, relative to the symmetric-information economy. Intra-generational transfer of income is shown to promote growth so long as the redistribution gives rise to an increase in net worth positions of borrowers.
JEL Classification Numbers: G21, O16, O40     

农村金融发展与农村经济增长——一个动态演化分析视角

农村金融发展对于农村经济增长具有重要的推动作用.运用1978-2010年的相关数据和时变参数模型估计方法,就我国农村金融发展与农村经济增长之间的动态关系进行探寻.首先,协整检验与误差修正模型的估计结果显示:无论是长期还是短期,农村金融发展规模对于农村经济增长具有正向促进作用,而农村金融中介效率却对农村经济增长起到了负向抑制作用.时变参数模型的估计结果则进一步发现:农村金融发展规模对农村经济增长的促进作用在整体上呈现弱化趋势,当前的正向作用机制比较微弱;而农村金融中介效率对农村经济增长的抑制作用经历了一个先减弱后增强的“倒V”型变化过程.     

Does formal financial development crowd in informal financing? Evidence from Chinese private enterprises

The relationship between formal and informal finance is uncertain. They serve as substitute for high-quality borrowers but are complement for low-quality borrowers. As formal financial institutions expand, they may concentrate on high-quality borrowers or diversify among borrowers of different qualities. Using unique survey data from Chinese private firms, we are allowed to investigate the relationship for a group of borrowers who were considered as low-quality. We find that formal financial development imposes a crowd-in effect for private firms’ informal financing, especially in East China. There is heterogeneity between East and West China. We document that the crowd-in effect is greater for private firms with bank access or of large size.