Joint liability in a classic microfinance contract: review of theory and empirics

Purpose - The purpose of this paper is to investigate the role of joint liability in improving the repayment performance of a microfinance program. Design/methodology/approach - This is a systematic review of the theoretical and empirical literature. Findings - The theoretical literature has shown, using models of peer selection, peer monitoring and peer pressure, that joint liability overcomes both the informational and enforcement failures present in credit markets for the poor. However, the empirical literature does not yield a clear answer on how much of the success of microfinance programs can be attributed to the effect of joint liability alone without considering the effect of other instruments used by microfinance programs. Further, it is seen that joint liability does not work in isolation, but its effect is dependent on social, cultural and economic environment. Research limitations/implications - An important future research agenda could be to study the roles of different overlapping mechanisms in group lending and to look at their interactions. Practical implications - The concept of joint liability works well both in the rural and urban areas, but different social, cultural and economic factors should be analyzed before initiating a microfinance program. In developed regions, focus should be on strengthening peer selection and peer monitoring, as information problems are prevalent. In underdeveloped regions, the major problem is of strategic default, so the focus should be on strengthening social sanctions. Social implications - Findings can be used for optimal design of credit contracts for the poor. Originality/value - The paper reviews the existing literature on – “whether and how” – joint liability lending works in inefficient credit markets and comes up with practical implications for the microfinance sector.