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9 Whitehead J. Dipl. & Int'l Rel. 37 (2008)
Does the Microfinance Lending Model Actually Work

handle is hein.journals/whith9 and id is 205 raw text is: Does the Microfinance Lending Model Actually Work? by Rafael G6mez and Eric Santor Licrofinance institutions (MFIs) have expanded throughout the developing and developed world and now serve over 10 million households worldwide) Despite the relative poverty of their clients, MFIs have been able to extend credit to poor households, while still maintaining high repayment rates and financial sustainability. Much of this success has been attributed to MFIs innovative use of peer group lending-the practice of allocating loans to individuals with little or no collateral- but with social capital in the form of peers who are also co-applicants and who in many cases are jointly liable. Practitioners and pundits attest to the ability of group lending to increase incomes, consumption, and the stock of human capital for those households facing severe credit constraints. Recent theoretical and empirical work, however, has begun to cast doubts on many of these claims.2 Not surprisingly, the apparent success, or lack thereof, of peer group lending has drawn the attention of numerous development researchers. This paper wades into the microfinance debate by tackling two important problems. First, by directly comparing the repayment outcomes of group members to those of traditional individual borrowers, we go further than most previous studies that have only examined the relative performance of peer groups with different characteristics. Second, the paper addresses the question of how group lending operates by measuring the effects that peer group lending has on borrower incentives and the shaping of selection into the peer group program. In other words, the paper deals squarely with two questions that still remain largely unanswered in the microfinance literature: Does peer group lending lead to higher repayment rates when compared to traditional individual lending techniques? And if so, does the beneficial peer group effect stem from greater expost borrower effort or positive ex ante selection into the group lending program? These questions lie at the heart of current microfinance debates and therefore warrant close empirical scrutiny. Answering the first question would-depending on the answer legitimize or perhaps call into question MFIs preference for using group lending schemes over traditional individual liability. Conversely, a positive response to the second question Rafael Gomez is Senior Lecturer at the London School of Economics and Senior Research Fellow at the Centre for International Governance Innovation (CIGI). Eric Santor is Chief Researcher at the International Department, Bank of Canada. 37 The Whitehead Journal of Diplomagy and International Relations

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