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Is Group Lending A Good Enforcement Scheme for Achieving High Repayment Rates? Evidence from Field Experiments in Vietnam

Microfinance institutions employ various kinds of incentive schemes for repayment but estimating the effect of each scheme is not easy due to endogeneity bias. The Southeast Asian Studies Group II at IDE conducted field experiments in Vietnam to assess the role of joint liability, monitoring, cross-reporting, social sanctions, communication and group formation in borrowers’ repayment behavior.

They found that joint liability contracts cause serious free-riding problems, inducing strategic default and lowering repayment rates. When group members observe each others’ investment returns, participants are more likely to choose strategic default. Even after introducing a cross-reporting system and/or penalties among borrowers, the default rates and the ratios of participants who chose strategic default under joint liability are still higher than those under individual lending. The researchers also found that joint liability lending often failed to induce mutual insurance among borrowers. Those who had been helped or who had repaid a little in the previous round were more likely to default strategically and repay a little again in the current round and those who paid large amounts were always the same individuals.

This paper reports on a piece of academic research and is not so easy for a practitioner to follow. However, the topic is interesting and teh conclusions provide food for thought for institutions using a mutual guarantee system.

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