DP6194 Social Connections and Group Banking

Author(s): Dean S. Karlan
Publication Date: March 2007
Keyword(s): group lending, informal savings, microfinance, social capital
JEL(s): O12, O16, O17, Z13
Programme Areas: Development Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6194

Lending to the poor is expensive due to high screening, monitoring, and enforcement costs. Group lending advocates believe lenders overcome this by harnessing social connections. Using data from FINCA-Peru, I exploit a quasi random group formation process to find evidence of peers successfully monitoring and enforcing joint-liability loans. Individuals with stronger social connections to their fellow group members (i.e., either living closer or being of a similar culture) have higher repayment and higher savings. Furthermore, I observe direct evidence that relationships deteriorate after default, and that through successful monitoring, individuals know who to punish and who not to punish after default.