Credit market, microfinance organisations and joint-liability lending

Abstract

Access to small amounts of credit is generally regarded as an important factor to encourage entrepreneurial activity and to reduce poverty in developing countries where poverty levels are high. However, financial services do not reach the vast majority of people in developing countries, because commercial banks ration credit to the borrowers who are asset-constrained. Unable to pledge collateral, the poor borrowers are excluded from formal credit provided by commercial banks. To fill this gap in the market, microfinance organisations have been established to serve the bank-excluded customers in particular. However, many microfinance organisations have to rely on subsidies to be viable. The central aim of this thesis is to investigate how microfinance organisations could improve the repayment rates from loans provided to asset-constrained borrowers. If microfinance organisations achieve good repayment performance, they will gradually avoid the need to depend on money from taxpayers, and donors.

This thesis reviews theories about credit rationing, which is to examine the reasons of the failure of the credit market. This shows why commercial banks do not favour lending to poor people. The credit market for the poor nowadays is served by microfinance organisations. Therefore, this thesis uses a case study about the historical development of microfinance organisations of a less developed country to examine how microfinance institutions have evolved over time. From this, this thesis develops a taxonomy of microfinance organisations based on their main characteristics. This is to show that microfinance organisations are heterogeneous in terms of their sources of funding, legal status, and lending characteristics. Microfinance organisations have used joint liability lending or group lending to mitigate the asymmetric information problem. Group lending, where individuals borrow money from a microfinance organisation under a form of joint responsibility, exploits the information that borrowers have about each other, as well as the ability of borrowers to monitor, and to enforce repayment on each other, to help the lender to tackle the information problem.

Based on, and extending three models about joint liability lending, which is screening model of Ghatak (1999), and Ghatak and Guinnane (1999), the monitoring model of Stiglitz (1990), and the enforcement model of Besley and Coate (1995), this thesis develops hypotheses on joint liability lending can help microfinance organisations to mitigate the asymmetric information problem to achieve better repayment rates. It tests these theories using a large dataset. This thesis shows that joint liability lending should not be used in every circumstance, and not all microfinance institutions should apply this lending method. Nevertheless, under certain conditions, joint-liability lending is shown to increase repayment rates.