I met some Dutch Kiva lenders during a trip to Isla del Sol, Lake Titicaca in Bolivia who don’t like to loan to groups on Kiva because
- They miss out on the personal connection with one particular entrepreneur
- They feel like the loans amounts are too big so they feel they aren’t making as much of a dent in the group loan amount as they would have if they had lent to one entrepreneur
- They don’t get to see the entrepreneur at work if the photo is of a group of people at a meeting
Kiva has actually responded to points 1 and 2 by
- Improving the personal connection by enforcing a rule on its partner MFIs that group profiles must include a personal story about one of the members, preferably the president
- Creating limits on the maximum value of a group loan. Kiva imposes a $5000 limit on group loans for both Emprender and Arariwa, regardless of how many people are in the group.
Regarding the third point about photos, yes I would agree that the photo of a bunch of group members in one of Arariwa’s or Emprender’s white-walled classrooms isn’t as sexy as a photo of a farmer in his fields, or a pot-maker in his workshop, but group loans are a way for the microfinance institution to be more sustainable, especially considering the high costs an MFI faces.
Bare with me as I explain…
Both the MFIs I have worked with as a Kiva Fellow, Asociación Arariwa and Emprender offer both group and individual credit products, however, the majority of Arariwa’s clients and 40% of Emprender’s clients work within a banco communal (village bank). A banco communal basically acts like a mini financial institution. The MFI gives each member credit based on the amount they have requested and their ability to pay. Each member saves part of their loan and in some cases, can relend this money within the group and collect interest on this internal loan.
Here are some reasons why group loans work well in microfinance -
- Allows MFIs to go deeper into poverty – Group borrowers are often poorer than individual borrowers. Since the only collateral required of them is a mutual guarantee, group loans allow clients without assets – like appliances, vehicles, or property titles – to access credit. Group loans give MFIs the ability to offer credit to what would otherwise be considered much riskier, collateral-less borrowers. Very poor clients need support in ways that group mechanisms provide, and live in areas where the cost of mitigating risks without group mechanisms would be nonviable. Group mechanisms include a lot of costs that in rural areas are not really considered (people don’t value their time because the opportunity cost is low), but where monetary costs such as significantly higher interest rates or physical collateral (rather than social collateral) would prevent people form accessing credit.
- MFI Efficiency – With group loans, one loan officer can serve multiple people at the same time, which helps keep MFI costs down. Since loan values are small, the fixed costs of doing business are high compared to the interest earned from the loans. Group loans help MFIs like Asociación Arariwa or Emprender who work with the village banking methodology to be sustainability, especially when they have to travel far distances to visit clients.
- Kiva Efficiency – Publishing group loan profile on the Kiva website, the Kiva coordinator can meet and photograph 10-20 people at one time and upload one loan on the site instead of 20 individual loans. This brings down what we call the “cost of Kiva” for the MFI
- Mitigated Credit Risk – Asociación Arariwa, for example, insists that the borrowers guarantee each other’s loans in triangles. For example, Carmen Ruth will guarantee Dominga. Dominga will guarantee Sonia Patricia. Sonia Patricia will guarantee Carmen Ruth . And in many cases, the group is responsible for the loan payment from the group savings if the guarantor fails to pay.
- Group Education – One loan officer can effectively teach a whole group on various topics such as Financial Literacy, Business Training, Family Well-Being, Health. Here’s a link to a blog entry I wrote about Financial Literacy Training and Microfinance.
- Support and Solidarity – Group members are mostly neighbors who know each other or become close as they work together in a communal bank. Besides guaranteeing each other’s loans, group members can support each other with business advice and help with personal issues. How about a group of women supporting each other? More than 70% of Arariwa’s clients are women and 60% of the members of communal banks at Emprender must be female.
- Adverse selection before disbursement - In other words, how to select the right clients. Since people know their neighbors (though see criticisms below), reliable clients are able to select other reliable clients much more cheaply than MFIs are. If they might end up paying for somebody’s irresponsibility, then they make sure they pick responsible people to borrow with. Groups are formed according to risk levels and the groups assume the risk rather than the MFI.
- Ex-ante moral hazard – in other words, the risk of people using the money for activities other than those reported to the MFI. Groups ideally monitor the businesses that are chosen so that they don’t end up paying for somebody else’s business failure.
- Ex-post moral hazard – in other words, the risk of people making profits and then claiming that they can’t pay because they did not make the profits. Group members know if their neighbors are making money and make sure they cough up the money if the alternative is paying themselves.
Of course there all also some criticisms of Group Loans -
- Adverse selection before disbursement - Do people know each other too well so that they are not willing to enforce social sanctions? MFIs need to have rules to make sure that the right people are chosen.
- Adverse selection before disbursement - Often the MFI rather than the borrowers themselves who form the group and people don’t know each other well. It may be rash to assume they know the ins and outs of each others´ businesses. Here MFIs need to have rules to make sure that the right people are chosen.
- More work for poor clients - The benefits mentioned above mean that the poor clients are expected to put in a lot more work. This is an implicit cost that is not associated with individual loans. In rural areas, the opportunity cost of putting time into getting a loan is low. In order to mitigate risks using individual loan mechanisms, interest rates and collateral requirements would have to be much higher. Poor people are not willing to front these monetary costs.
- Group Meetings - Group mechanisms have a lot of meetings, which is also a cost. The low opportunity cost for attending group meetings for rural borrowers seems reasonable, but Emprender, Pro Mujer and some Arariwa clients are urban, and there definitely is a cost associated with leaving your market stall for half the day.
- Assuming Other’s Risk - Often it’s not effective for risk adverse people who are reluctant to assume other people’s risk. Educational programs help to reduce this problem. If people understand the system, they become less risk averse.
- Collusion - Groups can collude to cheat MFIs. MFI’s have to be strict in their monitoring so that this does not happen.
Weighing the pros and cons, I believe the village banking methodology works best for rural, poor clients who don’t qualify for individual loans, need group support and training and for MFIs to help alleviate costs of doing business with poorer clients where they have to travel far.
If you have thoughts about group loans, please feel free to leave a comment below and please consider supporting group loans on Kiva by loaning to Communal Banks!
Thanks to Cynthia McMurray, Kiva Field Support Specialist; Adam Kemmis Betty, Kiva Fellow, Bolivia; and David Bullon Patton and Martin Rotemberg from IPA for helping with me this entry. To learn more, please check out the book Economics of Microfinance as well as Kiva Fellow Julia Kastner’s Kiva Fellows blog entry about the Village Banking methodology.
Sheethal Shobowale is currently in her Kiva Fellow placement with microfinance institution (MFI) Emprender in La Paz, Bolivia after working for the last several months with Kiva partner Asociación Arariwa in Cusco, Peru.