Group versus Individual Liability: A Field Experiment in the Philippines

1. Group versus Individual Liability:A Field Experiment in the Philippines Xavier Giné World Bank Dean Karlan Yale University Innovations for Poverty Action

2. Motivation • Microfinance is typically seen as a solution to credit market failures faced by the poor • Group liability, a feature found in many micro loans is perceived as a key innovation that has contributed to this success

3. Motivation • Yet, in recent years, many micro-lenders have expanded rapidly using individual liability • In turn, this has motivated other lenders that were using group liability to shift to individual liability

4. Flexibility versus Sustainability • (Perceived) tradeoff for deepening outreach of microfinance • Flexibility (to increase demand) • Price flexibility • Liability flexibility • Term flexibility • Sustainability • Repayment • Covering fixed costs (reduce turnover)

5. Motivation • Need for better understanding of relative merits of group versus individual liability lending. “The best evidence would come from well-designed, deliberate experiments in which contracts are varied but everything else is kept the same” The Economics of Microfinance Armendariz de Aghion and Morduch (2005)

6. Very Simple Summary • What we did was very simple… • Took 169 preexisting centers of ~25 clients in a group liability program • Randomly chose 80 of them and removed the group liability. • All else remained the same. • Default did not change and more clients borrowed.

7. Theory and Evidence • Literature focuses on repayment, despite being only one aspect of profitability • Group lending solves informational asymmetries by shifting the burden from the lender to the clients (Ghatak and Guinnane, 1999) • Adverse selection (screening and sorting) • Moral hazard (ex-ante and ex-post) • It also creates an element of insurance

8. Theory and Evidence • Much less stress on client retention/growth • Members may reject close friends for fear of social sanctions • Some may be reluctant to borrow if information about other members is not available

9. Experimental Design • Institution: Green Bank of Caraga • Rural Bank in the central Philippines • Microfinance Operation started in 1999 • Group-liability lending program (BULAK) has over 400 centers and 19,000 clients • PAR (portfolio at risk) is 3.7%

10. BULAK Program • Program: BULAK (Bangon Ug Lihok Alang sa Kalambuan) • Target pop: Business women in rural areas • Two layers of liability: group and center • Initial Loan size: P3000 - P5000 ($60-$90) • Loan term between 4 - 6 months • Weekly center meetings • Weekly deposits in center, group, and personal savings accounts

11. Experimental Design Sample Framework • 169 centers in Leyte Island (161 existing in Aug. 2004 and 8 centers formed before Nov. 2004) • Centers handled by 11 credit officers in 6 branches Conversion of BULAK Centers • Removing group liability Group members are no longer liable for each other’s loan. • Dissolving center/group savings Savings are entirely personalized with NO change to total deposit. Randomization • Stratified by credit officer and center age • Done in three waves

12. Experimental Design 161 BULAK Centers May 2005 August 2004 November 2004 January 2006 8 New centers opened 2 centers dissolved 4 centers dissolved 11 Centers Converted 24 Centers Converted 45 Centers Converted Total 167 Centers 88 control 79 converted Total 169 Centers 134 control 35 converted 150 control 11 converted Total 135 Centers 66 control centers 69 converted centers

13. Results • Default • No change in default overall • Better performance in converted centers for individuals with tighter social network • Indicates that group liability is not necessary to mitigate moral hazard. • Growth • Retention increases • Program attracts more clients • Savings • No change • Loan size • decreases, slightly (savings withdrawal effect?)

14. Results • Evidence of monitoring effects • Both baseline and new clients in converted centers remember less about other members’ defaults • Evidence of selection effects • New clients in converted centers are less likely to predict defaults of other members correctly. • Social network • Mostly no change. Some small evidence of fewer side-loans (insurance?) in converted centers.

15. Conclusion • Evidence of mechanisms of screening & monitoring. • But they do not add up and lead to default! • Why? • Perhaps not enough time • Perhaps simply not economically significant

16. Next Steps • Design of New Areas (ongoing) Converted to individual liability Existing groups Stay Converted to individual liability after 1st cycle Group Stay New areas Individual lending Control