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How can you lend to poor people who can offer little or no collateral?
Actually it is not correct to assume that MFIs provide loans to poor people who lack collateral. Poor people simply lack traditional collateral in the form of property or land deeds. To overcome this MFIs use a number of methods to ensure repayment. These include the use of one or two personal guarantors (often respected local community leaders) and the use of solidarity groups in which groups of poor people (usually 4-5) approach the MFI collectively for a loan. Within the groups, members decide how much each individual should receive from the group loan and the group as a whole is responsible for repayment.
Group members are usually from within the same community, know each other well and are best placed to judge if each other’s business ventures are going to be successful or not and they can also monitor loan use and encourage each other to repay. Lending to solidarity groups or individuals with personal guarantors has proved remarkably successful with very high loan repayments rates of around 97% - these are in fact higher than the repayments rates that commercial banks experience with wealthy borrowers. What explains the success of group lending? There are several reasons each of which may play a role of varying significance depending upon the context:
- Peer Monitoring: the ability of members to monitor the investment behaviour of one another during the course of a loan, making sure that each member only undertakes safe investment projects with the loans.
- Social Ties: the social cohesion that exists in some communities means that the sanctions that a member would receive from the group for defaulting results in each member wanting to repay faithfully.
- Group Pressure: the pressure between borrowers to repay means that the group can expel non-paying members if they default, thus excluding them from continued access to credit.
