Group Lending, Matching Patterns, and the Mystery of Microcredit: Evidence from Thailand

How has the microcredit movement managed to push financial frontiers? If borrowers vary in unobservable risk, then group-based, joint liability contracts price for risk more accurately than individual contracts, provided that borrowers match positively assortatively by project riskiness (Ghatak, 1999, 2000). This more accurate risk-pricing can attract safer borrowers and rouse an otherwise dormant credit market. We extend the theory to include correlated risk, and show that borrowers will seek to undo joint liability by matching to anti-diversify risk within groups. We test for positive assortative matching by project riskiness, and for intra-group diversification of risk, using data on Thai microcredit borrowing groups. We propose a new nonparametric methodology to test for homogeneous and positive assortative matching in a single dimension. Multidimensional matching analysis is also carried out using Fox’s (2010a) matching maximum score estimator. Evidence is found for a) positive assortative matching by project riskiness and b) risk anti-diversification within groups, though not along occupational lines. This evidence supports the idea that group lending improves risk-pricing by embedding a discount for safe borrowers, and thus can plausibly explain part of the unprecedented rise in financial intermediation among the world’s poor. However, the anti-diversification results point to a potential pitfall of voluntary group formation, and suggest strategies for lender intervention. ∗Department of Economics, Michigan State University; +1 517 3558306; [email protected].