Joint liability microcredit was considered to be the cornerstone of the microfinance movement. This liability structure was believed to overcome the many information asymmetries inherent in lending to poor borrowers. In the last two decades, both economists and practitioners have evaluated and debated the effectiveness of joint liability in practice. The evidence so far is inconclusive and recent years have seen a shift away from joint liability towards more flexible contracts with individual liability or group lending without imposing joint liability.
In this paper we use a natural experiment setting in order to compare the performance of borrowers under both individual and joint liability. The analysis is based on the decision of a
Microfinance organization Akhuwat in Pakistan to shift from individual liability to joint liability lending in February 2011 without introducing mandatory group meetings. All outstanding loans at the time of the shift continued as individual liability till they matured. Under the individual liability model, each borrower had to be guaranteed by one person and this guarantor could not borrow from the organization till the loan expired. Complaints from the guarantors about this motivated the change in the liability structure. This decision was made centrally and communicated simultaneously to all branches. It is important to note that this was not accompanied by any changes to loan structure - loan amount, duration and repayment frequency remained the same as before.
The relevant sample for our analysis are the set of borrowers who had an outstanding individual liability loan at the time of the announcement of the switch and who go on to take out a loan under joint liability. We use several different identification strategies to estimate the impact of this shift from individual to group lending and find a significant improvement in borrower performance under joint liability as compared to individual liability loans across all specifications. Borrowers are about 0.6 times as likely to miss a payment in any given month under joint liability setting relative to individual liability. This effect is robust to inclusion of controls for number of times the individual had borrowed before, the stage of the loan cycle and branch and calendar fixed effects. It appears that the pressure exerted by joint liability is leading to a beneficial improvement for the organization without having to invest in the administrative cost of group meetings.
There is variation in behavior across groups and we look at the characteristics of group members (information collected through a survey of the borrowers) to try to explain it. By exploiting the exogenous variation in amount of time borrowers had till expiry of their individual liability loan at the time of announcement of the switch, we find that that more time that borrowers from both genders had, the more likely they were to form groups with people they had pre-existing social ties with (as measured by knowing them from before group was formed and meeting them weekly). However, we do not find evidence that other dimensions like informal insurance networks or being from the same caste matter in improving group discipline. This time that borrower had to form group also correlated positively with borrower discipline in making payments.
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