Optimal Joint Liability Lending and With Costly Peer Monitoring

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

Carli, Francesco and Uras, Burak R., Optimal Joint Liability Lending and With Costly Peer Monitoring (December 2, 2014). CentER Discussion Paper Series No. 2014-075, European Banking Center Discussion Paper Series No. 2014-013, Available at SSRN: https://ssrn.com/abstract=2533401 or http://dx.doi.org/10.2139/ssrn.2533401