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Library » Microfinance and the Mechanics of Solidarity Lending: Improving Access to Credit through Innovations in Contract Structure

Microfinance and the Mechanics of Solidarity Lending: Improving Access to Credit through Innovations in Contract Structure
Apr 1999, Jaffer, J.
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Reviewing the solidarity lending model and its success

One of the most intractable economic problems for poor countries has been the high price or outright unavailability of credit in rural communities. One of the few concepts that have succeeded in expanding the availability of credit has been "microfinance," a practice that involves the provision of small loans (generally of a few hundred dollars or so) to borrowers without conventional collateral. The success of microlending has been especially striking because its benefits have accrued primarily to groups ignored by traditional development assistance - the poorest segments of poor countries' populations - and to women in particular.

This paper explains how a large part of microfinance institutions' success can be traced to their practice of a system known as "solidarity lending." Under this system, would-be borrowers form groups (usually of between three and six), within which each member agrees to guarantee the loans of the others in the group. If any one individual member defaults on his or her loan, the other members of the group are required to cover the shortfall.

This paper reviews insights of the informational economics literature that explain the link between information asymmetries and credit market failure, and then shows why solidarity lending dramatically decreases the costs of information, particularly where institutional infrastructure is weak and borrowers' projects are small.

The paper concludes that the solidarity lending model was created by trial and error. Nonetheless, the model is a remarkably apt answer to the insights of the informational economics literature, which first advanced the connections between institutional poverty and asymmetric information, between asymmetric information and credit rationing in the formal sector, and between credit rationing in the formal sector and the existence of an insular informal sector.

By exploiting the differential between lenders' and borrowers' access to information, the model has revolutionised the way in which credit is provided to the very poor, and has allowed MFIs to vastly expand the proportion of poor countries' populations with access to affordable credit.

[Adapted from author]

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20 Aug 2010




Johanna Posada Elevar United States

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Publisher(s):
Harvard Law School