Delegated Monitoring and Moral Hazard in Underdeveloped Credit Markets

Abstract

This paper originates from the current move to individual-based lending systems by many microfinance institutions and the fear that this move will lead to a decrease in access to credit for the poor. More specifically, the paper examines how an individual-based lending scheme can be devised such that moral hazard issues can be addressed, even when straight forward individual lending is unable to do so. We show that the moral hazard problem can be solved if microfinance institutions hire informal lenders to monitor the borrowers. In addition, we show that by offering the informal lender a demandable debt contract a simple incentive scheme could be obtained that induces the informal lender to collect the necessary information, and to truthfully reveal this information.

Keywords: Moral Hazard, Underdeveloped Credit Markets, Delegated Monitoring

JEL Classification: D82, O16, O17