Risk diversification through multiple group membership in microfinance

Abstract

We consider group formation in the joint liability setting in microfinance. Joint liability imposes additional liability of having to repay for group partners should they fail to repay. Multiple group membership allows diversification of that risk, and therefore, is welfare enhancing for risk averse agents. Welfare enhancement occurs even when the total loan of an agent is unchanged. Therefore, multiple borrowing is not synonymous with over-borrowing.

Keywords:

• microfinance
• risk diversification
• joint liability
• risk aversion

JEL Classification:

• G11
• G18
• O12
• O16

Notes

¹ For example, see http://www.bbc.co.uk/news/world-south-asia-11997571

² For example, the Government of India is proposing a law to limit a microfinance borrower to only one joint liability group and restricting the number of MFIs a borrower can approach to two. For full details of this proposed law, see, http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/YHMR190111.pdf

³ Another explanation is that borrowers wish to substitute MFIs for other traditional sources (like moneylenders) without necessarily increasing their overall loan burden. However, since MFIs ration the amount of loan given to an individual, multiple borrowing is inevitable for such substitution.

⁴ See McIntosh and Wydick (2005) and Guha and Roy Chowdhury (2013) for the welfare implications of changes in interest and default rates as the number of MFIs increase.

⁵ Usually, a MFI lends only once to an agent. Therefore, an agent may have to approach n distinct MFIs to obtain n loans. Whether the n lenders are distinct or not is not an important factor in our analysis.

⁶ The assumption of a countable infinite set of agents ensures that an agent never runs out of potential group partners.

⁷ We are implicitly assuming Y > 2R to ensure an agent is able to repay if all her partners default.

⁸ The finiteness of n* follows from the concavity of U_n and the convexity fo g_n.