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Structure of this class
• Description of “the classic” GLJR contract
• Overcoming adverse selection
• Overcoming moral hazard
• Evidence
• Limitation of the GLJR contracts
• Some background
First experiments in Jobra near Chittnagong University. Loans made to individuals
M. Yunus and associates soon realized that extending loans to groups had the following advantages: economies of scale, and saving in screening, monitoring and enforcing
Description of the GLJR contract
Like ROSCAs and Credit Cooperatives
Early microfinance institutions involved groups
Each participant borrower responsible for the debt of others
Loans are granted individually
If entire group’s debt is not repaid, all individuals are excluded from future refinancing
Common wisdom: incidence of default is reduced because participant borrowers are in a relatively superior position to screen, monitor and enforce repayments due to geographical proximity and other links
Delegation of agency problems due to asymmetric information from microfinance lenders to the borrowers efficiency
Overcoming Adverse Selection
Assume:
• Each individual has a one-period project requiring $1 investment
•There are two types of borrowers: “safe” and “risky”
•Fraction of the population that is safe is q<1, and risky 1-q
•A dollar invested by a safe borrower yields y with certainty and a a dollar invested by a risky borrower yields with probability p
There will be assortative matching (s,s) and (r, r) and:
where g is the probability of luck in a risky pair
And the break even rate:
Which is smaller than the break even rate in the absence of GLJR
Intuition: the risky types can repay back their loans more often thanks to GLJR.
Risk passed on from bank to risky borrowersInterest rates can be reducedDeserving safe types back into the market