Informal Credit and Group Lending: Modeling the Choice

In a given geographical area, what happens when a farmer, a craftsman, or a small merchant has the opportunity to chose between participating in a group loan or resorting to an informal money-lender? This paper presents a theoretical model that examines such situations, placing group lending and informal credit in a competitive market context, and also allowing for some degree of market power of the informal lender. Results show that the higher the extra-value.as compared to the market value.that the borrower perceives on his collateral, the more he will tend to prefer group lending, but there is no collateral e¤ect if the borrower evaluates his collateral as the market does. Important determinants of the choice are the value of loosing future credit opportunities.generally called .reputation.., the e¢ ciency of lenders in managing funds and subsidies granted to group lenders. We also .nd that subsidies can help lowering the impact of opportunistic behavior on the preference for group loans. Furthermore, group lending does not seem to o¤er particular risks of adverse selection, since it can be preferred both by borrowers with highly secure projects and those with highly risky projects