Social capital dilemma in joint liability lending

This study investigates the dilemma of joint liability lending: while aiming to leverage social capital to enforce microcredit contracts, it may paradoxically undermine that very social capital. We analyze how the lending methodology affects social capital and propose solutions to mitigate its negative impacts. Our game-theoretic model examines the strategic interactions at the enforcement stage in which clients’ reciprocity motivations can lead to relationship breakdown, even when loan repayment is feasible. We demonstrate that factors such as loan size, lender penalties, and project success probability can exacerbate the tension between clients, increasing the risk of social capital damage. Our analysis suggests that borrower–guarantor pairs with access to punishment mechanisms beyond direct social sanctions, particularly through mediation by common friends, are more suitable for joint liability lending, as they are less likely to experience social capital damage.