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The purpose of this paper is to investigate the role of joint liability in improving the repayment performance of a microfinance program.

This is a systematic review of the theoretical and empirical literature.

The theoretical literature has shown, using models of peer selection, peer monitoring and peer pressure, that joint liability overcomes both the informational and enforcement failures present in credit markets for the poor. However, the empirical literature does not yield a clear answer on how much of the success of microfinance programs can be attributed to the effect of joint liability alone without considering the effect of other instruments used by microfinance programs. Further, it is seen that joint liability does not work in isolation, but its effect is dependent on social, cultural and economic environment.

An important future research agenda could be to study the roles of different overlapping mechanisms in group lending and to look at their interactions.

The concept of joint liability works well both in the rural and urban areas, but different social, cultural and economic factors should be analyzed before initiating a microfinance program. In developed regions, focus should be on strengthening peer selection and peer monitoring, as information problems are prevalent. In underdeveloped regions, the major problem is of strategic default, so the focus should be on strengthening social sanctions.

Findings can be used for optimal design of credit contracts for the poor.

The paper reviews the existing literature on – “whether and how” – joint liability lending works in inefficient credit markets and comes up with practical implications for the microfinance sector.

The purpose of this paper is to evaluate the role of social capital in a microfinance contract.

Systematic review of the theoretical and empirical literature on the role of social capital in microfinance.

The theoretical literature has shown using models of peer selection, peer monitoring and peer pressure that group lending with joint liability overcomes both the informational and enforcement failures present in credit markets for poor. However findings from the empirical literature conclude that social capital should not be taken as a single concept but should be considered in light of its different aspects which may be having different effects on the performance. For example, the trust between the borrowers, cultural and social homogeneity has been found to have more significant affect on repayment performance in contrast to the incentives due to peer pressure. The groups formed by family members and relatives are consistently been reported to have weakening influence on repayment.

For a same program the effect of social capital on performance can be different for different geographies and different classification of subjects and thus should be studied before initiating a microfinance program in any social setting.

The borrowers should be encouraged to form groups with others who are more trustworthy and not with those they are just having an acquaintance with. The borrowers should be encouraged to come to aid of those who are victims of negative externalities. The positive experiences will lead to reciprocity of actions in future. The borrowers should be discouraged to form groups with family members and relatives.

It analyzes both theoretical and empirical literature by disentangling different aspects of social capital within groups and their effects on group performance.