Social capital: does it matter in a microfinance contract?

Purpose – The purpose of this paper is to evaluate the role of social capital in a microfinance contract. Design/methodology/approach – Systematic review of the theoretical and empirical literature on the role of social capital in microfinance. Findings – The theoretical literature has shown using models of peer selection, peer monitoring and peer pressure that group lending with joint liability overcomes both the informational and enforcement failures present in credit markets for poor. However findings from the empirical literature conclude that social capital should not be taken as a single concept but should be considered in light of its different aspects which may be having different effects on the performance. For example, the trust between the borrowers, cultural and social homogeneity has been found to have more significant affect on repayment performance in contrast to the incentives due to peer pressure. The groups formed by family members and relatives are consistently been reported to have weakening influence on repayment. Practical implications – For a same program the effect of social capital on performance can be different for different geographies and different classification of subjects and thus should be studied before initiating a microfinance program in any social setting. Social implications – The borrowers should be encouraged to form groups with others who are more trustworthy and not with those they are just having an acquaintance with. The borrowers should be encouraged to come to aid of those who are victims of negative externalities. The positive experiences will lead to reciprocity of actions in future. The borrowers should be discouraged to form groups with family members and relatives. Originality/value – It analyzes both theoretical and empirical literature by disentangling different aspects of social capital within groups and their effects on group performance.