Group Lending and Financial Intermediation: An Example

I magine a small group of people, each of whom borrows money from a financial intermediary. The intermediary does not require collateral because the borrowers are relatively poor and do not own much property. Instead, the intermediary requires group members to be jointly liable for each other’s loans. That is, if a member defaults on a loan, the rest of the group is liable for the remainder of the loan. If the group does not honor this joint obligation, then the entire group is cut off from future access to credit. The lending arrangement I just described is not fictitious. Two million villagers, most of whom are female and poor, borrowed in this way from the Grameen Bank in Bangladesh. In Bolivia, 75,000 urban entrepreneurs, roughly one-third of the banking system clientele, borrowed money via group loans from BancoSol. Even in nineteenth-century Ireland, many rural residents took out loans similar to group loans. Motivated in part by group lenders in less-developed countries, organizations in the United States have developed similar programs. The 1996 Directory of U.S. Microenterprise Programs lists 51 organizations that issue group loans. The programs operate in both rural and urban areas. Often they are run by nonprofit organizations. The underlying idea of group lending is to delegate monitoring and enforcement activities to borrowers themselves. Borrowers who know a lot about each other, such as those who live in close proximity or socialize in the same circles, are the most promising candidates for group lending. For example, the rural villages that Grameen lends in would seem ideally suited for group lending,