Microfinance and markets: New results for the Besley-Coate group lending model

Microfinance currently experiences a huge inflow of private investors and a surge in the use of market instruments. This raises the question of what market equilibria in microfinance markets look like and which kinds of market failure tend to afflict them. The present paper conducts an equilibrium analysis of Besley and Coate's (1995) group lending model with enforcement problems.We show that a consideration of repayment rates alone is not sufficient to predict market outcomes, as it is biased towards group lending. Market equilibria are likely to exhibit the same kinds of market failure as equilibria in adverse selection models, viz., financial fragility, redlining, and credit rationing. Social sanctions ameliorate these problems, but do not eliminate them.