Article | World Bank Economic Review | September 2013

Liability Structure in Small-Scale Finance

by Fenella Carpena, Shawn Cole, Jeremy Shapiro and Bilal Zia

Abstract

Microfinance, the provision of small individual and business loans, has experienced dramatic growth, reaching over 150 million borrowers worldwide. Much of the success of microfinance has been attributed to attempts to overcome the challenges of information asymmetries in uncollateralized lending. However, very little is known about the optimal contract structure of these loans, and there is substantial variation across lenders, even within a particular setting. This paper exploits a plausibly exogenous change in the liability structure offered by a microfinance program in India, which shifted from individual to group liability lending. We find evidence that the lending model matters: for the same borrower, the required monthly loan installments are 11 percent less likely to be missed under the group liability setting in comparison with individual liability. In addition, compulsory savings deposits are 20 percent less likely to be missed under group liability contracts.

Keywords: Microfinance; Emerging Markets; Financial Markets; Legal Liability; Banks and Banking; Banking Industry; India;

Citation:

Carpena, Fenella, Shawn Cole, Jeremy Shapiro, and Bilal Zia. "Liability Structure in Small-Scale Finance." World Bank Economic Review 27, no. 3 (September 2013): 437–469.