Group Lending under Dynamic Incentives as a Borrower Discipline Device

In recent years group lending has become an increasingly utilized tool for providing credit access to the poor in developing countries. Using empirical results from first‐hand field research on Guatemalan borrowing groups, this paper develops a simple game‐theoretic model of group lending. Results from the model show that through peer monitoring, the threat of group expulsion, and the safety net of intragroup credit insurance, group lending mitigates some risky investment behavior that would otherwise occur under an individual borrowing contract. The credible threat of social sanctions against group members who misallocate borrowed capital further reduces instances of such behavior.