| The success of the Grameen Bank in Bangladesh has shown that it is possible to provide a large number of low income people with financial services using a group lending methodology. As a result, group lending programs funded by international donors have proliferated at a rapid pace throughout the world. The mechanisms of group lending, such as peer pressure and group solidarity are touted as instruments to attain favorable repayment rates. However, repayment rates vary dramatically from one program to another, suggesting an inherent instability in the financial technology.;Based on the work of Besley and Coate, a model for group lending repayment has been devised. The model incorporates stabilizing and destabilizing determinants of group loan repayment. Influences that can increase the probability of loan repayment include the effective use of group dynamics (ex ante and ex post peer pressure and group solidarity) as well as other factors such as appropriate training and leadership. The degree to which pressure versus solidarity occurs is shown to be dependent on the reason given for the repayment problem and can be formulated as an "intragroup contract" for insurance purposes.;Negative externalities can diminish the probability of successful group loan repayment. The "domino effect" occurs when one or more members of a credit group default due to the default of other members. Another negative influence on repayment occurs when the credit terms and conditions are no longer appropriate for each member as credit cycles continue, creating an inherent "matching problem" as group lending is repeated over time.;In order to evaluate the prevalence of these positive and negative externalities, a survey of 140 groups was accomplished in Burkina Faso. A mean and covariance structural model was used to test the determinants of repayment problems arising and whether or not the loans were recovered. This econometric method allowed for the use of latent variables with multiple indicators, a more complex error structure, and non-metric categorical variables. The results indicated that urban, homogenous groups with good leadership and training and prior history of working in groups had the highest probability of repaying the loan. However, the domino effect and matching problem were significant factors influencing loan default, creating a destabilizing effect on overall repayment. The results of the empirical model suggest that modifications to project design could enhance loan recovery. |
