Optimal Joint Liability Lending and With Costly Peer Monitoring
CentER Discussion Paper Series No. 2014-075
European Banking Center Discussion Paper Series No. 2014-013
30 Pages Posted: 4 Dec 2014
Date Written: December 2, 2014
Abstract
This paper characterizes an optimal group loan contract with costly peer monitoring. Using a fairly standard moral hazard framework, we show that the optimal group lending contract could exhibit a joint-liability scheme. However, optimality of joint-liability requires the involvement of a group leader, who heavily takes care of the partner's repayment share in bad states and gets compensated in expected terms. This key result holds even for a group of borrowers, which exhibits homogeneous characteristics in productivity, risk aversion and monitoring costs. Our work rationalizes the widely-applied group-leadership concept of micro finance programmes as an outcome of an optimal contract.
Keywords: Micro-finance, Joint-liability, Group leader
JEL Classification: G21, O12, 016
Suggested Citation: Suggested Citation