The Structure of Social Collateral: Embeddedness and Economic Performance in Microfinance

Abstract

We examine the explicit use of social relationships as collateral against loan default, a core feature of modern microfinance. What structural factors determine whether borrower relationships serve as an effective security? Through a rich combination of data on microfinance clients in Sierra Leone, including ethnographic, affiliation survey, GPS, and loan performance, we explore how a microcredit group's spatial structure affects its embeddedness and the efficacy of social collateral. We posit that group structure determines the salience of alternative social mechanisms underlying cooperation. The effects of group structure on economic performance are statistically tested using a dataset of 5,582 repayment-transactions made by 1,884 microfinance clients in Sierra Leone from 2006-2011. Our findings highlight two structural features of social collateral: (1) A group's spatial concentration improves economic performance up to a certain level; after which, the effect reverses and performance declines. Contrary to predominant expectations in the microfinance literature, groups are significantly at risk of overembeddedness. Though embeddedness enhances the ability to sanction, communicate, and build solidarity, high levels reduce the willingness to enforce the loan. (2) Groups that consist of multiple spatial fragments produce significantly worse economic performance. Socially, such groups are prone to split into factions and hinder overall cooperation.

The most recent version of this paper can be found at https://ssrn.com/abstract=3579121.

Keywords: Africa, economy, geography, social capital, social networks

JEL Classification: A14, D12, D64, D71, O12, R10