INTRODUCTION TO MICROFINANCE: REVIEW OF ARTICLE & REFLECTIVE WRITE-UP 1

Introduction to Microfinance:

Review of Article & Reflective Write up

Prabhakaran C (M2019HRM043)
INTRODUCTION TO MICROFINANCE: REVIEW OF ARTICLE & REFLECTIVE WRITE-UP 2

Peer Monitoring and Credit Markets

By Joseph E. Stiglitz

Introduction
This article is an attempt at developing a general theory of peer monitoring. The major problem of money
lenders is that the borrower should be prudent in using the funds, which would enable in the repayment.
Majorly, there are two solutions for tackling these issues in the rural sector would be Peer Monitoring
practices and having a Co-signer. Even after the encouragement of governments towards modern banking
institutions to venture into rural sector, very few banks such as Grameen Bank of Bangladesh were
actually successful. While most of the banking institutions suffered huge losses, the local moneylenders
were able to make profits and continue to lend at higher rates. The higher rates were due to the following
factors: (i) High rates of default (ii) High correlation among defaulters and (iii) high cost of screening
applications. Local moneylenders were able to use their local knowledge, were able to separate high risk
and low risk borrowers and charge appropriately; monitor more effectively and thus lowering the default
rate. Grameen bank gave loans to self-formed groups, who are mutually responsible for repaying loans.
All the members of the group cannot obtain credit until the previous loans are settled. This is called as
peer monitoring. Grameen bank appears to be a success with giving small loans at an average of 70
dollars per month. They distribute around 475,000 loans at a default rate of under 2% which on
comparison with other lenders the default rate is somewhere around 60-70%. In this process, the risk is
transferred from the bank to the members of the self-formed group, who will do the monitoring for the
bank. This paper sets out to model and answer, if the gains from improved monitoring worth the cost of
increased interdependence.

Methodology
In this research, two models of lending have been considered for the study, where one is a basic model or
generally practiced standard model of lending whereas the other model is the Grameen Bank of
Bangladesh's experimental model of peer monitoring way of lending. Various scenarios were considered
and the relationship between gross returns- Investments, loan size-interest rate charged (indifference
curve), the inflation of loan size and interest rate in the selection of safe/risky projects and loan size-
liability of fixed utility are arrived. Understanding the customers and analyzing the risk of repayment is
a difficult task. Since, the chance of a wrong lending would still be 50% linked to a lot of behavioral
aspects.

Conclusion
Based on the analytical research, it is found that the peer monitoring way of lending is found to be a safer
option than the basic model that is usually used for money lending.
The „Switch Line‟ is defined as those combinations of scale and rate of interest, for which the individual
is indifferent between the two projects. When there is no interaction with the switch line, an optimum
amount for lending can be achieved. Thus, increasing the chances of repayment and bringing down the
defaulters and bad debt.
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From the research, we are able to deduce some of the ingredients in the design of successful peer
monitoring systems:
 The members of the peer group must be incentivized for monitoring the actions of their peers. In
the Grameen bank, this was achieved by the fact that the members of the peer group are jointly
liable for the repayment of loans and that they will not be allowed for further loans until the
repayment of earlier loan.
 The size of the peer group should also be tailored beneficially. With small groups, the risk
associated with the single members default is increased, but the incentives for peer monitoring is
increased. The small sizes eliminated the issue of free rider as well.
 There are strong incentives for groups with similar characteristics to form. Villagers have an
informal advantage over formal credit institutions in selection. Thus, the self-formed groups are
an important ingredient in the success of grameen bank

The major impediment on the development of effective capital markets was the inability of the outsiders
of the village to monitor the loans. On the contrary, within the village, risks are adequately highly
associated and there are necessarily few folks with wealth that the lending market is both imperfectly
competitive and carries with it high risk premia.
This article reflects on how the peer group system is better than the cosigning provision which has
traditionally been viewed as a way of increasing the effective collateral behind the loan. Cosigning
increases risk and it has been proved that the gains from peer monitoring more than offset the loss in
expected utility from the increased risk-bearing. In spite of the advantages, the inadequate legal systems
make it difficult to force contracts for the development of peer monitoring. The Policy reforms might
encourage private capital banks to enter this market. However the inadequate legal implications remain
as an impediment for the same. Although legal reforms can facilitate the use of peer monitoring in private
markets, even short of such fundamental reforms, well-designed government lending programs, taking
advantage of the opportunities provided by peer monitoring, may, in these circumstances, be an effective
second-best policy.
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Borrowing Money, Exchanging Relationships: Making

Microfinance Fit into Local Lives in Kumaon, India
BY RACHAEL GOODMAN

Introduction:
More than 70% of the Indian population belongs to the rural society and our Country‟s economic
development depends upon the development of the Rural Society. In order to eradicate rural poverty,
various efforts were taken to develop agricultural and allied activities and provide employment
opportunities. Along with the various rural employment programmes and employment schemes by the
government, the modern banking institutions such as Co-operative Banks, commercial banks and
Regional rural banks were encouraged to be set up at rural regions to provide financial credit facilities.
These modern banking institutions were not able to succeed in accomplishing the demands of rural
women, rural artisans, marginal farmers, agricultural labourers, etc. primarily living below the poverty
line. Microfinance Institutions are the oldest and traditional financial institutions in the world, they have
adapted to the changes, and have used various credit lending models across the world. There are various
methods through which microfinance services are provided. They include:
Self Help Groups: It is a method of informal association of individuals, who come together and work
towards improving their economic conditions. It acted as a tool of change for the poor and marginalized.
These groups depend on the concept of “Self Help” to incentivize self-employment and poverty
alleviation. Nevertheless, a one size fits all approach cannot be used to live up to the needs of the
regional or local population. Thus, Microfinance solutions must be tailor made and be able to supply to
financial depravity at the smallest scale. This article details one of the significant causes that explains
why microfinance models are not implemented the way project planners and donors expect it.

Methodology
An ethnographic research was conducted. The author stayed in Kumaun for 18 months along with the
local people and supported the volunteers of Pahari Sansthan NGO in conducting Self Help Group
meetings. The use of ethnography is justified for this research as it delivers a detailed and faithful
representation of psychology and attitudes of the local rural population. The region-specific nature and
subjectivity proves to be useful in finding and investigating relevant rural attitudes and emotions that
undercut the Self Help Groups objectives.

Highlights
One of the major reasons for failures of microfinance models is that they fail to accommodate ground
level factors. For positive execution of any development project, examining the prevalent socio-cultural
practices for effective targeting of beneficiaries is essential.
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At Kumaun, the NGO conducted the microfinance scheme through women self-help groups (SHG) and
sought high size loan to be distributed recurrently so that SHG could gather sufficient interest on the
credit to sustain them.

However, Kumaon‟s culture of borrowing practice was different. The transactional relationship was not
just restricted to monetary terms, but also extended to social and emotional support also. It was not
linked with the economic concept of loan mechanism but was considered as a help from kin, friends and
colleagues. There was neither interest nor stipulated repayment time associated with it. There were other
factors such as respect and dignity alongside with not putting an undue burden on the creditor as well as
the debtor. This constituted a part of the moral economy which is built on social and moral responsibility
and equality. It is a startling mechanism as the moneylender is typically viewed as someone who has an
upper hand in any economic exchange leaving the debtor at his/her mercy. The exchange registers were
also not maintained and hence auditing was also not feasible. Another highpoint of Kumaun‟s monetary
exchange practices was that it was not specific to support the livelihoods of the people. The Self Help
Groups were started with the purpose of developing the functional capacity of the poor and the
marginalized in the field of employment and income-generating activities. The majority of the lending by
the Self Help Group was mainly to support housing, repair, wedding and medical expenses rather than to
support an enterprise or income generating source. Hence, people used to take loans for their daily
requirements such as housing needs and expenses due to unpredictable events and natural disasters. The
Project was tailored to the needs and cultural practices of the community with the help of fieldworkers
from NGO. These Self Help Groups were not monopolized and became a moral obligation within the
community to look after each other and a defector will result in being ostracized by the community.
Hence, the microfinance project is customized as an instant source of cash.

Conclusion
The aim of the Self Help Group was to offer a collateral-free loan with conditions decided by the group
at the market-driven rates. Various other factors such as understanding, a collective leadership, and
mutual agreements were used to resolve conflicts. Subsequently, Self-Help Groups arose as an effective
mechanism for delivering microfinance services to the rural population. Though, for better targeting, the
solutions must be tweaked according to the locality and the people in need of it. Alike, many instances of
local microfinance solution are found in Ashankur Rural Women Centre of Ahmednagar district of
Maharashtra where the SHG group was shaped by women who faced domestic abuse by their husbands.
The SHG acted as a platform for knowledge transfer among women and increased collective conscience
in them with addition to providing a sound financial base.
At the global scale, Programme Hubungan Bank Danksm (PHBK) project in Indonesia and the
Chikola groups of K-REP in Kenya also use similar group-based credit provision models. The core
philosophy is that the inadequacies and weaknesses at the individual level can be compensated by the
collective responsibility and security provided by group formation of those individuals. The grouping of
individual members is then used for multiple purposes: education and awareness building, collective
bargaining power, peer pressure etc.
Thus, the microfinance solutions for rural population must go past providing credit to ensure social
wellbeing of the society.
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DETERMINANTS OF MORAL HAZARD IN

MICROFINANCE: EMPIRICAL EVIDENCE FROM
JOINTLIABILITY LENDING PROGRAMS IN MALAWI
Franklin Simtowe, Manfred Zeller and Alexander Phiri

Review
The four problems caused by imperfect information are moral hazard, adverse selection, lack of
insurance and lack of enforcement. The concept of peer monitoring is referred as Joint liability
lending. The utilization of social collateral in the absence of physical collateral along with its
effectiveness and shortcomings are discussed. Research has been conducted over the hazards of
peer monitoring and how continued access to credit plays a crucial role in the repayment of
earlier debts and acts as collateral. However, when multiple banks compete within themselves,
this becomes a problem, with access to new loans from other banks, where the dependency of the
individual with the same bank is reduced. When we evaluate the cost of peer monitoring and
interest rates, these costs doesn‟t matter for the borrower. Even at times of good returns, the
borrower would not prefer to pay the loan back. Instead, the borrower would try to invest the
benefits and reap further utility.
Moral hazard is a common occurrence in Malawi. In the case of Malawi Rural Finance Company
(MRFC), it is identified that reluctance is the main reason for default of loans, rather than
inability of the borrower to pay. The article tries to deduct the extent to which moral hazard can
be tested by using peer selection, peer monitoring social ties, peer pressure, dynamic incentives,
and matching problems. A private good such as access to financial credit is made reliant on a
public group such as a group member‟s repayment of the borrowed money. At certain occasions,
the borrower might have the ability to repay the loan, but decides to reinvest in a risky project for
higher yield or does not put enough efforts and ends up misusing the funds. These instances can
be tackled with the concept of distribution of risk rather than focusing the risk towards a single
person. It could also happen, where the borrower feels he was able to get the required returns for
the investment and then finds an optimum route for divergence of funds into elsewhere and hence
the repayment is stalled. Self-selected groups formed by homogenous characteristics with
assertive matching process end up with less risk borrowing and thus reduces moral hazard
leading to lower equilibrium rates which in turn leads to superior part efficient outcomes in
comparison with individual borrowing.
When we look deep into the model, highly successful institutions, who have implemented the
joint liability lending programs, have relied upon highly motivated local staff for monitoring and
organizing the groups. The peer pressure plays a role on how the borrower deals with social
sanctions and how effective these practices are on the borrower. However, this effect works only
when the borrower is fearful of sanctions from both bank and community. Productivity tests were
conducted amid groups on the functions of loaned capital, human capital to the derivative of
utility difference between the human capitals. On comparison with the average land holding,
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which is one of the major factors in the distribution of loans, there was no correlation with the
repayment of the loans. Consequently these tests support the findings that the loan repayment is
more on the unwillingness to repay than the inability of the borrower to repay the loan.
Survey results show that there are high chances that the field assistants and the credit assistants
have friends and relatives in the formed groups. However the credit assistants were found to be
more objective in the group formation, and also for recommendation of loans, leading to lower
rate of loan defaults than the field assistants. With accordance to the nature of the job, the field
assistance inclines to form groups, which are more associated with farming practices.
Meanwhile, the credit assistants incline to form more groups over the business side with much
netter scale and profits. Around 30% of the groups have been formerly associated with other
lending organizations, while 80% of the groups surveyed comprised members from other SACAs
or NGOs. There are instances of the village chiefs pushing for their relatives and friends who
have defaulted earlier into groups that are well credit worthy. This halts the purpose and
mechanism of group formation by the FAs and CAs. Hence, a few good borrowers are left with
no options other than to share risk with risky borrowers for credit access.
The explanatory variables comprise peer selection, peer monitoring variables, screening,
variables to catch a point and the extent of social ties, peer pressure etc. Peer pressure and peer
monitoring helps in reducing the moral hazard. There are three models of which the first model is
dependent on direct penalty on the borrower, while the others aren‟t dependent to a single
borrower. The rise in loan size increases the chances in capitalizing in risky projects leading to
moral hazard. Meanwhile, the size of group and programs remains only as dummies. The
corresponding problems are the new members and new loan cycles leading to additional moral
hazards. Dynamic incentives show the capability of collective willingness of group affiliates to
repay the defaulters loans, disciplinary actions in contradiction of risky projects hence by
protecting honest borrowers and attainment towards a point to make all borrowers honest.
Additional policies to handle incongruity combine programs of joint liability and individual
liability. Discovery of peer selection process needs to be enhanced, that the participants of the
group come together more on mutual trust rather than being formed by an intervention by the
credit/ field assistants. Joint liability lending institutions should rely on more social cohesions to
solve problems such as low outreach, limited impact and lack of financial self-sustainability as
the above mentioned three forms the pillars of the micro-finance throughout the work and models
to be emulated.