Solidarity and Microfinance
26 Pages Posted: 3 Jun 2011 Last revised: 17 Oct 2016
Date Written: April 20, 2012
In this paper we analyze the role of peer solidarity in fostering productive investments in the context of microfi nance. When there is asymmetric information between lenders and borrowers and loans are not collateralized, borrowers may divert loans towards current consumption rather than investing in production. We assume that solidarity is accorded by a network of individuals close enough to the borrower (peers) so as to share private information about hidden effort in the productive project. The model shows that peer solidarity might have contrasting effects on the effort in the productive investment. On the one hand, since solidarity transfers are contingent on the effort, they increase borrowers incentive to invest. On the other hand, solidarity tranfers decrease the marginal utility of future consumption at the expense of productive investment. The predictions of the model are tested on households enrolled in micro-lending programs who were surveyed in Bangladesh by the World Bank during the period 1991-1992. Empirical fi ndings suggest a positive relationship between the financial capability of borrowers' solidarity network and the share of loans invested in productive activities.
Keywords: Micro-Finance; Social Networks; Intertemporal Consumption.
JEL Classification: O16, G21
Suggested Citation: Suggested Citation