Group lending, local information and peer selection

This paper analyzes how group lending programs use joint liability to utilize local information that borrowers have about each other's projects through self-selection of group members in the group formation stage. These schemes are shown to lead to positive assortative matching in group formation. Faced with the same contract, this makes the effective cost of borrowing lower to safer borrowers: because they have safer partners, conditional on success their expected dues to the lender are lower than that of riskier borrowers. The resulting improvement in the pool of borrowers is shown to increase repayment rates and welfare. (C) 1999 Elsevier Science B.V. All rights reserved.