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Abstract: |
Based on micro mechanisms of microfinance, we attempt to present a theoretic framework for group lending, in which agents’ reputation mechanism endogenously forms, mitigating borrowers’ incentive problems. Joint liability acts effectively as a screening device, inducing borrowers’ self-selection and enforcing peer monitoring mechanism, thus monitoring function transferred from financial institutions to borrowers. The formation of homogenous groups is possible, achieving through a signaling mechanism of non-monetary side payments. We demonstrate that reputation cost is the core mechanism for group lending and defaulted firms suffer from costly cost, deprived of the last lending channel and driven away from group lending market.
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