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Does group lending overcome cost constraints of lending to the poor?

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Does group lending overcome cost constraints of lending to the poor? Since the success of the Grameen bank in Bangladesh, group-lending micro-finance schemes have been seen by many as the most effective way of ensuring credit is available to the those who previously would not have had access to it due to the cost constraints they face when entering either formal or informal credit markets. Indeed, the UN proposed in 1997 that $21.6 bn would be put invested in micro-finance schemes in order to reach some 100m of the worlds poor over the following 8 years (Wydick, 1999). The purpose of this essay is to evaluate how effective at allocating credit to the poor group-lending schemes actually are. Firstly, however, a brief overview of credit markets will be given in order to look at the type of cost constraints the poor face when entering credit markets. Empirical evidence of various group-lending schemes will then be analysed in order to gauge how these schemes help the poor overcome the aforementioned constraints. Credit markets: Many developing countries are characterized as having a high percentage of informal lenders in their capital markets. The main reason for this is that formal lenders (banks, govt backed institutions, etc) will not possess the necessary personal knowledge of their borrowers required to gauge how risky that borrower will be. They will only lend to those who can provide guarantees that they will not default, or that they can still repay the loan in the event of the investment that the loan was intended for failing. ...read more.


Instead of lending many small loans to different individuals, larger loans are lent to different groups of borrowers. Reducing the number of loans provided will in itself reduce the costs to the lender. These groups are normally put together on a self-selection basis, which often leads to groups of homogenous quality (although Zeller, 1998 argues, justifiably that groups will seek to diversify the employment within their members in order to lower the overall risk to the group). Borrowers will also have a lot more information regarding the reputation, wealth and reliability of his/her fellow group members. This itself acts as a screening device as low risk borrowers will not want to risk their credit rating by grouping themselves with high risk types. If a borrow does default on his payment then he faces social sanctions imposed by the village. Apart from the unwanted humiliation that this may entail, he may lose certain village privileges, or, at worst, be expelled from the group and therefore not have access to credit. This is by no means an idle threat, Bruce Wydick (1999) showed that a repayment rate for the FUNDAP group lending scheme in Guatemala of 97% was mainly a result of peer monitoring, ensuring that the perceived benefits of defaulting were vastly out-weighed by costs of doing so. Stiglitz (1990), Varian (1990) and Rashid & Townsend (1992) ...read more.


1998) researched the effects of 13 different micro-finance schemes, including group- lending schemes such as BancoSol in Bolivia, BRI in Indonesia and the Grameen bank. It found that the average increase in a borrowers income to be significantly lower for those borrowers already below the poverty line. For the BancoSol and BRI the difference was startling - increases of 270% and 540% for the whole sample compared to increases of just 101% and 112% respectively for those below the poverty line. There is no doubt that group-lending does allow the poor access to credit markets but the extent on that success also depends on the targeting of the program and the manner in which it is implemented. This will vary from country to country, from village to village, so it is not sufficient just to take the model of the Grameen bank as a blueprint for success and apply it indiscriminately. Furthermore, there is a lack of research into how effectively group-lending schemes target the poor, indeed, that effectiveness itself is very hard to measure and so it is very hard to gauge how effective these programs are, especially as these figures can quite possibly be massaged by financial institutions or governments. However, within the limited scope of this essay, I can conclude that group-lending does go some way to overcoming the cost constraints faced by the poor when entering credit markets, but the effectiveness will vary from scheme to scheme, and more research regarding this effectives should be undertaken before any definite conclusions can be made. ...read more.

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