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Examining the Effects of Information and Group Member Relationships EXAMINING DETERMINANTS OF GROUP LOAN REPAYMENT IN THE DOMINICAN REPUBLIC A thesis presented to the faculty of the Center for International Studies of Ohio University In partial fulfillment of the requirements for the Masters of Arts Danielle Matta June 2004 This thesis entitled EXAMINING DETERMINANTS OF GROUP LOAN REPAYMENT IN THE DOMINICAN REPUBLIC By Danielle Matta Has been approved for the Center for International Studies by Julia Paxton Assistant Professor of Economics Josep Rota Director, Center for International Studies Matta, Danielle. M.A. June 2004. Examining Determinants of Group Loan Repayment in the Dominican Republic (88pp.) Thesis Advisor: Julia Paxton This thesis proposes to determine if different components of group dynamics in microfinance group lending programs such as information symmetry, group size, and group member relationships affect both group loan repayment and group mechanisms such as peer pressure and group solidarity. The research presents empirical evidence from the ADOPEM group lending program in the Dominican Republic. A Tobit Model was created from the data that shows smaller group size, groups composed of family members, and group solidarity can all lead to higher loan repayment rates. Approved: Julia Paxton Assistant Professor of Economics To Justin for his love and support 5 Table of Contents Chapter 1 Introduction..........................................................................................................................7 History of Microfinance.......................................................................................................8 Purpose of Study............................................................................................................... 11 Theoretical Framework - Joint Liability............................................................................14 Theoretical Analysis Relevant to Thesis - Group Dynamics.............................................17 Empirical Studies - Group Dynamics ................................................................................22 Theories and Empirical Studies - Information Exchange..................................................27 Methodology......................................................................................................................29 Chapter 2 Group Lending and ADOPEM ..........................................................................................32 Explanation of Variables and Data Analysis .....................................................................45 Tobit Model .......................................................................................................................67 Chapter 3 Discussion of Results.........................................................................................................72 Recommendations for ADOPEM ......................................................................................76 Suggestions for Further Study ...........................................................................................79 Conclusion .........................................................................................................................80 Bibliography ......................................................................................................................82 Appendix A: Questionnaire ...............................................................................................86 6 List of Tables Tables 1. Requirements for Loan Officer Categories............................................................36 2. Correlation of Feelings/Response..........................................................................53 3. Reasons for Preference of Individual Loan ...........................................................55 4. Correlation for Preference of Loan Type...............................................................55 5. Descriptive Statistics..............................................................................................56 6. Correlation for Group Relationships......................................................................61 7. Correlation for Time Know Members ...................................................................62 8. Correlations for Information Exchange .................................................................64 9. Correlations for Approaching Group.....................................................................64 10. Correlations for Ability to Resolve Problem .........................................................65 11. Correlations for Time with ADOPEM...................................................................66 12. Determinants of Loan Repayment .........................................................................71 Graphs 1. Reasons for Personal Loan Repayment Problems .................................................58 2. Reasons for Group Member Repayment Problems ...............................................60 7 Chapter 1 Introduction Due to the enormous success of the Grameen Bank in Bangladesh, microfinance institutions have become the main resource for the poorest sectors in developing countries that have the incentive and creativity to start a small microenterprise, but lack the collateral, guarantor or credit history required to receive a loan from a commercial bank. Loans are provided to villages (village banking), to groups ranging in size from 2 to 14 members (group solidarity) or to individuals. Under group solidarity lending, each member receives a loan for the development of a small business. Several models show that certain mechanisms must exist within the groups to provide incentives for loan repayment and thus ensure high loan repayment rates. The first, ‘joint liability’ specifies that each member be held responsible for the other members. The second, ‘step’ or ‘progressive’ lending dictates that each member can receive a new, larger loan amount only after all members in the group have fully repaid the previous loan. Other mechanisms that relate directly to group dynamics and facilitate enforcement of repayment include peer pressure, social sanctions, and group solidarity. This thesis proposes to examine these mechanisms through empirical research, noting the causal effect they may have on group repayment rates. It also proposes to determine if group composition and the level of information symmetry among group members affect group dynamics and ultimately the loan repayment rates. 8 History of Microfinance The provision of formal rural credit began in developing countries during the 1960s. At this time the development strategies focused on increasing agricultural production and meeting the needs of rural people. Also at this time, the lack of capital stymied economic growth. Farmers did not have access to capital for the inputs required to grow large amounts of rice and wheat during the Green Revolution of the 1960s and 1970s. The model for providing loans at this time was a subsidized credit model. Under this model, institutions provided credit at low interest rates. By 1971 there was documentation that this model had failed due mostly to poor repayment rates, which caused the projects to run out of money and donors to stop lending. Also, the subsidized loans did not reach the targeted group of low-income farmers because they encouraged corruption and thus were often co-opted by wealthy businessmen. In the 1980s a new model emerged called the ‘best practices’ model or sustainable microfinance. This model is currently still in place. Under this model, microfinance institutions provide both credit and savings services. Through savings, clients generate their own loan funds and thus eliminate the need for donors. Microfinance institutions and NGOs charge interest rates high enough to cover their costs and eventually make a profit. Also under this model, previously excluded groups such as the poor, indigenous groups, women and the illiterate sectors of the population are targeted. Several new approaches to microfinance have emerged under this model. The first approach, individual lending, focuses on larger, urban based, production-oriented businesses. It targets clients with collateral or a cosigner. As most poor people starting their own business do not have either collateral or a cosigner, this type of loan is for 9 clients who have been operating a small business for a significant amount of time. The loan size ranges from $100 to $3,000 (Ledgerwood, 1999, p.83). Savings, training and technical assistance may or may not be provided under this approach. Interest rates are higher than those in the formal sector but lower than informal sector loans. The second approach to microfinance, village banking, focuses on community- managed credit and savings associations. The Foundation for International Community Assistance (FINCA) developed this microfinance model in the mid-1980s to provide access to financial services in rural areas, build community self-help groups and help members accumulate savings. The membership of a village bank normally consists of between thirty and fifty people, most of which are women. A sponsoring microfinance institution provides training and funding to the bank. All members must sign a loan agreement and offer a collective guarantee. Then the sponsoring organization provides a loan based on the aggregate sum of individual members’ loan requests. The interest rates on the loans are commercial rates between 1 and 3 percent per month. The first loan period is normally
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