China Agricultural Economic Review

Determinants of repayment performance of group lending in China: Evidence from rural

credit cooperatives' program in Guizhou province
Zhang Qinlan Yoichi Izumida
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Zhang Qinlan Yoichi Izumida, (2013),"Determinants of repayment performance of group lending in China",
China Agricultural Economic Review, Vol. 5 Iss 3 pp. 328 - 341
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CAER
5,3 Determinants of repayment
performance of group lending
in China
328
Evidence from rural credit cooperatives’
program in Guizhou province
Zhang Qinlan and Yoichi Izumida
Graduate School of Agricultural and Life Sciences,
The University of Tokyo, Tokyo, Japan
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Abstract
Purpose – The purpose of this paper aims to explore how borrower and group-level characteristics
affect repayment decisions of group borrowers by highlighting the case of rural credit cooperatives
(RCCs) in Guizhou province in Southwest China.
Design/methodology/approach – The Logit model was applied to test the determinants of
repayment performance of RCCs’ group lending. The authors used the survey data of 245 farm
households in Guizhou province, collected in 2008.
Findings – The empirical results indicate that there is a serious mismatch between joint liability
mechanisms and the social and economic conditions in rural China. Mechanisms such as threatening to
withhold defaulters’ future loans from RCCs failed to work. In addition, higher household incomes also did
not improve repayment performance. However, factors such as a higher degree of acquaintanceship in a
group, migrant income, and employment in government agencies, positively improved the chances of
repayment.
Practical implications – Group lending is more suitable for poorer areas with few opportunities for
migration and limited access to finance. In addition, constructing the trustworthy relationship between
micro-lenders and customers and designing diverse and flexible financial services to meet
heterogeneous demands are equally important.
Originality/value – This paper is an attempt to empirically explore the determinants of repayment
performance in group lending programs in China. The results provide meaningful policy implications
for the government and rural financial institutions.
Keywords China, Rural development, Rural finance
Paper type Research paper

China Agricultural Economic Review
Vol. 5 No. 3, 2013
pp. 328-341
q Emerald Group Publishing Limited
1756-137X
DOI 10.1108/CAER-08-2012-0083
1. Introduction
Group lending, one of the major innovations of microfinance, has been widely
replicated and adopted in developing countries over the past three decades. It is a
contractual innovation to overcome imperfect information in rural financial markets by
addressing four main problems: adverse selection, moral hazard, monitoring, and
enforcement (Besley and Coate, 1995; Ghatak and Guinnane, 1999; Gine and Karlan,
2010). Despite the widespread popularity of joint liability contracts, empirical studies
have not shown complete success. One criticism is that the benefits of group lending
have been exaggerated and the method is often too rigid to meet borrowers’ needs
(Conning, 2005; Armendariz and Morduch, 2005). In addition, joint liability may lead to
excessive tensions among peers and may even worsen the dropout rate. Today, many
 micro-lenders have chosen flexible approaches, and tend to pay more attention to Repayment
individual liability contracts. performance of
China introduced microfinance in the form of joint liability in 1993; subsequently,
group lending schemes have expanded significantly. Currently, there are many types group lending
of microfinance institutions (MFIs) in rural China. Among them, rural credit
cooperatives (RCCs) have been the most popular ones. Statistics from the China
Banking Regulatory Commission (CBRC) show that by the end of 2007, there were 329
over 78 million rural households benefitting from RCCs’ microloans, accounting for
33.2 percent of overall households in China. The outstanding amount of rural group
loans distributed by the RCCs, the Rural Cooperative Banks, and the Rural Commercial
Banks during this period stood at 135.1 billion Yuan (He et al., 2009).
Although RCCs’ microloan programs generated positive profits soon after their
operations, many researchers claimed that they still faced difficulties such as improving
operating efficiency, liberalizing interest rate caps and so on (He et al., 2009). Among these
difficulties, it is crucially important to improve loan recovery performance, especially that
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of group lending programs. Yang (2012) pointed out that in some areas, default rates of
group loans reached 10-50 percent and resulted in considerable losses. In addition, the scale
of group lending in many branches began to shrink (Du, 2008). According to the Almanac
of China’s Finance and Banking (2003-2009), from 2002, the outstanding loans of group
lending have been much lower than those of individual lending. Both the academic
researchers and practitioners have questioned the sustainability of group lending in China.
Therefore, it is critical to examine the mismatch between joint liability mechanisms
and the social and economic conditions in China, and explore how borrower and
group-level characteristics affect borrowers’ repayment performance. We adopt Logit
regression to analyze the case of RCCs in Guizhou province in Southwest China.
The sample for this study is the survey data of 245 farm households collected in 2008.
The rest of the paper is organized as follows: Section 2 briefly reviews the rural
financial system and the development of group lending in China. Section 3 presents the
theoretical framework, while Section 4 discusses the data used in this study.
In Section 5, the econometric results are presented and the final section offers
conclusions and suggestions for the improvement of microcredit provisions in China.

2. Rural financial system and development of group lending in China

In considering the important role of RCCs in China, it is helpful to begin with an
explanation of China’s rural financial system. Three major rural financial institutions
operate in rural China: the Agricultural Bank of China (ABC), the Agricultural
Development Bank of China (ADBC), and RCCs. However, in reality, only the RCCs
function as originally designed. The ABC, as one of China’s four specialized banks,
withdrew from the rural financial market in the process of commercialization during
the 1990s. On the other hand, the ADBC, a policy bank, has been providing loans
mainly to state-owned enterprises. Consequently, for the vast majority of rural
individuals, the RCCs have been the only source of formal loans. In 2009, there were
60,325 branches countrywide, providing loans to 82.42 million rural households
(People’s Bank of China (PBOC, 2010)). However, the RCCs face many difficulties.
CGAP’s report (2005) shows that by the end of 2001, 46 percent of the RCCs in China
were making losses, 58 percent had liabilities exceeding their assets, and 53.3 percent
had a negative net worth.
 CAER The microfinance movement in China has existed for around 30 years. Its history
5,3 can be separated into three stages: the experimental phase, the expansion phase, and
the normalization and institutionalization phase. The first stage, called the initial
experiment phase here, lasted from 1994 to 1999. During this period, most projects
were operated by non-governmental organizations (NGOs) and international
organizations. Meanwhile, local governments and formal financial institutions, such
330 as ABC and ADBC, began to provide microloans for rural development. The commonly
accepted view was that their participation led to an important change in the structure
of microfinance in China. Traditional, small-scale projects gradually transformed into
large-scale programs operated by the government and state-owned banks (He et al.,
2009). However, these governmental projects invited strong criticism due to their
failure to achieve high recovery performance and weakness in reaching the poor
(Park and Ren, 2001).
The expansion phase, characterized by a wide participation of formal financial
institutions, lasted from 1999 to 2004. During this period, the most noteworthy
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programs were those conducted by the RCCs. In July 1999, the PBOC issued the
Provisional Method of Microcredit Loans Management of RCCs for Rural Households,
initiating the practice of individual and group lending activities. According to Gale and
Collender (2006), in 2003, about half of the RCCs had inducted group lending programs
and provided $9.4 billion loans to 9.5 million clients. By June 2005, the outstanding
loans had increased to $11.7 billion. Therefore, the RCCs had gained market leadership
in rural areas.
The third period, beginning in 2005, can be regarded as a normalization or
adjustment phase. New types of MFIs were encouraged to enter the rural financial
market. In 2005, the PBOC launched a pilot program of credit-only microloan
companies. By the end of 2006, the CBRC granted village/township banks, credit-only
companies, and postal saving banks to develop microloan businesses in China.
Although these policies were expected to promote competition and expand credit
opportunities in low-income communities, no significant improvement has been
observed as yet.

3. Theoretical model
A series of theoretical literature on microfinance has proposed numerous models to
explain how the joint liability approach works before and after the loans’ disbursement
(Ahlin and Townsend, 2003; Brehanu and Fufa, 2008; Armendariz and Labie, 2010).
Before the disbursement of loans, most lenders face the problem of adverse selection.
In principle, group lending with joint responsibility can mitigate this inefficiency by
encouraging the applicants to self-select their best partners (Ghatak and Guinnane,
1999; Van Tassel, 1999; Godquin, 2004; Armendariz and Morduch, 2005). It is expected
that borrowers from the same village have sufficient information about incomes,
repayment capacities and creditworthiness of neighboring households, and that they
will use this information to form homogeneous groups. However, after the loan
disbursements, the MFIs may confront moral hazard and enforcement problems.
Available literature shows that threatening not to refinance defaulters or offering
larger loans to borrowers who repay their debts, creates an incentive for peer
monitoring, peer pressure, and intra-group help among the borrowers (Ghatak and
Guinnane, 1999; Armendariz and Morduch, 2005). Under the threat of being excluded
 from future loans if one group member defaults, the group has the incentive to monitor Repayment
their peers to use the loans in profitable ways, and to exert pressure to make the performance of
potential defaulter reconsider his decision. Further, each member will support the
others if they face repayment difficulties. group lending
While group members have many incentives to achieve high repayment rates, they
still face a prominent problem of high monitoring costs, even for members living in
close proximity. Armendariz and Morduch (2005) argue that group lending can 331
encourage borrowers to help each other only if peer monitoring is not very costly and
social sanctions are sufficiently strong. In addition, under some conditions, borrowers
under group lending contracts may collude and this creates serious risks for MFIs
(Besley and Coate, 1995; Laffont and Rey, 2003).
The analytical framework here involves the borrowers’ repayment behavior after
loan disbursement. When the project returns are realized, how do group members
make their repayment decisions? Under the individual lending contracts, borrowers
simply compare their own costs and benefits of default. However, under group-lending
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contracts, their decisions are also influenced by other members. The repayment
mechanisms such as peer monitoring, mutual help, and peer sanctions help in
heightening motivation for repayment. At the same time, these methods result in high
monitoring costs. Thus, borrowers must evaluate the overall costs as compared to the
benefits of default.
Based on the above analysis, we assume that a borrower has an opportunity to obtain
a loan from one MFI. He could generate p units of net income from the microloan
investment project and w units from other activities. When the loan is due, the amount
including both principal and interest r should be repaid. At the same time, he may
encounter some income shocks during the loan period, such as natural disasters,
sickness, unemployment, and so on. These shocks may affect his repayment behavior.
Here, we denote l as the losses due to negative shocks, thus the household’s total
expected income can be represented as p þ w 2 l. In the case of default, the borrower
may not repay the principal and interest, but his access to loans from this MFI would
cease. Denote the present value of all future loan profits as B, and the function of private
profits as p(· ). Under the individual lending contracts, if the net expected benefits of
default are smaller than B, the borrower should choose to repay. That is:

pðp þ w 2 lÞ 2 pðp þ w 2 l 2 rÞ , B ð1Þ

Under the group lending contracts, the defaulter should also receive social sanctions (S )
from other group members. Therefore, the borrower will repay only if:

pðp þ w 2 lÞ 2 pðp þ w 2 l 2 rÞ , S þ B ð2Þ

Another factor that affects a borrower’s repayment decision is monitoring costs. When a
borrower suspects that monitoring costs are higher than the evaluation of his
investment’s income, he may be prone to default and evade the responsibility of peer
monitoring. Let C be the monitoring costs. Then equation (2) becomes:

pðp þ w 2 lÞ 2 pðp þ w 2 l 2 r 2 CÞ , S þ B; and

ð3Þ
pðp þ w 2 l 2 rÞ . C
 CAER Consequently, based on the theoretical model, this paper proposes the following three
hypotheses:
5,3
H1. The borrower will be more likely to repay if the expectation of getting new
loans from RCCs is high.
H2. The borrower will be less likely to repay if intra-group monitoring costs are
332 high.
H3. The borrower will be more likely to repay if social sanctions are strong.
Besides, these three hypotheses, whether household attributes such as income level,
land size, family size, and so on influence the repayment performance must be
considered.

4. Data
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We collected data in Chishui city, in Guizhou province, from March through April of
2008. The surveys covered 245 households in four densely populated villages. In each
village, we randomly handed out 80 questionnaires to households that had ever
received group loans from RCCs and helped them respond to all the questions. The
questionnaire included items about borrowers’ socioeconomic characteristics, labor
market participation, land usage, household income, negative shocks, financial
activities, repayment performance, and group structure.
Guizhou is a very poor province located in Southwest China. In 2009, more than
20 percent of the population was still below the poverty line. In comparison to other
provinces, poor people in the province are mainly concentrated in remote and
mountainous areas, where the vast majority of households are engaged in agricultural
production. In the early 1990s, microfinance projects started in Guizhou, and
provisions of loans through microfinance become one of the most important tools for
poverty alleviation.
We selected Chishui, a moderately developed city in the northwest of Guizhou as the
survey area. The city is in a large mountainous area, with poor traffic conditions, and a
poorly developed industrial sector.
Table I highlights the major socio-economic characteristics of the sample
households. First, a majority of sample households earn their income from multiple
sources. The agricultural land of both paddy and dry land area was small in the survey
area, but almost all households were engaged in agriculture. About 82.9 percent were
planting bamboo. In addition, over half of the sample households had at least one
member working outside the home, and 12.7 percent were operating off-farm
businesses (OFB). Thus, agricultural income, bamboo income, and non-farming income
made up the majority of households’ overall income. Second, most of the sample
households were lower-income households. In the survey, each respondent was asked
to appraise his household income level. The proportion of households assessed as
low-income, middle-income, and upper-income was 36.7, 59.2, and 4.1 percent,
respectively. In addition, a strikingly large percentage of sample households had low
education levels.
Concerning households’ financing sources (this information is not listed in the table),
the informal sector played an important role. Most (73.9 percent) of the
sample households reported to rely first on relatives when they needed money.
 Repayment
Household characteristics Proportion Mean
performance of
Age of the household head group lending
Less than 30 7.3 41.0
30-50 77.6
More than 50 15.1
Education level of the household head 333
Illiterate or primary school 25.3
Junior middle school 62.0
Senior middle school 10.6
College or above 2.1
Income level
Low income 36.7
Middle income 59.2
Upper income 4.1
Whether the family owns OFB
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Yes 12.7
No 87.3
Total paddy area
Less than 0.1 hectares 55.1 0.11
0.1-0.2 hectares 27.8
More than 0.2 hectares 17.1
Total dry land area
Less than 0.1 hectares 53.5 0.11
0.1-0.2 hectares 34.7
More than 0.2 hectares 11.8
Total bamboo grove area
Without bamboo grove 7.1 0.17
Less than 0.1 hectares 49.8
More than 0.1 hectares 33.1
NFM working outside the home
0 43.7 0.82
1 or 2 members 53.9 Table I.
More than 3 members 2.4 Socioeconomic
characteristics of the
Source: Field survey in Guizhou sample households

Another 14.3 percent attached the most importance to borrowing from friends. However,
37.6 percent of the respondents still considered RCCs as their second most important
source of borrowing.
Table II shows the relationship between loan usage and repayment rates. We found
that the borrowers used RCCs’ microloans for limited purposes: about 46.9 percent of
the households used their loans for building rural roads, 22.9 percent for agricultural
production purposes, and 14.3 percent for children’s education. Only a few loans were
used for building houses, medical treatment, living expenses, marriage and funeral
expenses, and so on.
The information on other key variables of the group lending contracts is presented
in Table III. Loan amounts ranged from 800 to 15,000 Yuan, and the group size often
exceeded five persons, sometimes going up to ten persons. Moreover, group members
have close relationships with other members in terms of kinship, residential distance,
and cooperation.
 CAER Before moving to the econometric analysis, we try to examine the relationship
5,3 between repayment performance and loan and group characteristics. For the analysis,
borrowers are classified into two categories: those who have fully made their required
loan repayments by the due date are classified as “repaid”, and those who have missed
repayments are classified as “default” (Sexton, 1997; Coke, 2002). Field data shows that
serious repayment problems existed in the survey area. The default rate was
334 34.7 percent (65 households), and only 65.3 percent (160 households) repaid both the
principle and interest before maturity.
In order to analyze the correlation between loan size and borrowers’ repayment
performance, we categorized the sample households into three groups by individual
loan size: less than 3,000 Yuan, 3,000-5,000 Yuan, and more than 5,000 Yuan.
No obvious difference has been found in the three groups. However, the repayment

Loan usage Samples Proportion

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Agricultural production 56 22.9

Building rural roads 115 46.9
Building houses 17 6.9
Medical treatment 7 2.9
Children’ education 35 14.3
Living expenses 4 1.6
Table II. Marriage or funeral arrangements 5 2.0
Relationship between Other 6 2.5
loan usage and
repayment rates Source: Field survey in Guizhou

Variable Mean SD Min. Max.

Size of the loan (Yuan) 4,228.20 1,916.297 800 15,000

Number of group members 7.64 1.691 5 10
NFM 4.64 1.203 2 9
NFM in the labor force 3.16 1.062 1 6
Dummy: ¼ 1 if the borrower is male, 0 if the
borrower is female 0.85 0.359 0 1
Percentage of group peers who are relatives of the
respondent 0.43 0.188 0.00 0.80
Percentage of group peers who are from the same
village as the respondent 0.87 0.204 0.22 1.00
Percentage of group peers who have cooperative
relationships with the respondent 0.66 0.422 0.00 1.00
Dummy: ¼ 1 if the borrower needs a loan from
RCCs in the near future 0.44 0.498 0 1
Dummy: ¼ 1 if RCCs are the borrower’s first choice
for a future loan 0.09 0.281 0 1
Number of outside loan opportunities besides RCCs 1.58 0.688 0 3
Table III. The farthest distance from the respondent’s house to
Descriptive statistics of a peer’s house (km) 8.18 2.692 3.0 15.5
some variables of group
lending contracts Source: Field survey in Guizhou
 rates varied greatly for different loan usage. Loans used for medical treatment and Repayment
building rural roads were the least repaid, 14.3 and 59.1 percent, respectively. In performance of
comparison, when borrowers used the money for building houses or for marriage or
funeral arrangements, the repayment rates were relatively high. group lending
Another question to consider is how the homogeneity among group members
affects the repayment rates. According to the data, if the proportion of peers from the
same village to the respondent was higher, his repayment performance was better. In 335
addition, cooperative relationships between peers, such as planting bamboo or running
a brick kiln together, also had a positive effect. When the respondent had cooperative
relationships with more than 80 percent of his group peers, his repayment possibility
reached 82.1 percent.

5. Econometric results
Empirical model
To test the hypotheses discussed in Section 3, we adopt the Logit model. The model
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aims to identify the relationship between the probability of repaying a loan and a
vector of explanatory variables such as: borrower and group-level characteristics,
borrower’s expectation of future loans from RCCs, intra-group monitoring costs, and
social sanctions. The dependent variable yi is dichotomous with a value of 1 if the
sample borrower i completed repayment before the due date. 1i is an error term.
The model is formulated as the equation below:
1
pi ¼ prob ð yi ¼ 1j zi Þ ¼ ;
1 þ e 2zi
Taking the natural logarithm:
pi X X X X
zi ¼ log ¼aþ b1i x1i þ b2i x2i þ b3i x3i þ b4i x4i þ 1i
1 2 pi
The first category (x1i) indicates the number of family members (NFM), the number of
household members in the labor force (NFL), age of the household head (AGE), sex of
the borrower (SEX), and loan size (AOL). This category of variables is used to test
whether certain individual characteristics or loan size helps the client heighten the
possibility of repayment.
The second series of variables (x2i) indicates a household’s income and income
related factors. We use six variables: a dummy for investment profitability (OCP),
which denotes whether the returns on the microloan investment can cover the principal
and interest required to repay; owned farming area (FA); owned bamboo area (BA); a
dummy for OFB such as managing shops for the sales of candy, beverages, and so on
in the village; the number of household members working outside the home (NWO);
and a dummy for external shocks such as sickness, crop losses, or owing other debts
during the loan period (HNS). Diverse income sources, including both farming and
non-farming income, are expected to improve the repayment performance.
The third category (x3i) is used to test H1 on the borrower’s expectation of future
loans from RCCs. Three variables are taken into consideration: the number of outside
loan (NOL) opportunities besides RCCs, a dummy variable for the need of a loan from
RCCs in the near future (NL), and a dummy variable for whether RCCs are the
borrower’s first choice for a loan (RFC).
 CAER Finally, the variable denoted as x4i reflects the homogeneity among group members
5,3 and the intensity of social ties. Since homogeneity and social ties are expected to affect
both intra-group monitoring costs and social sanctions, we test H2 and H3 together.
Five variables are used here: percentage of group members who are relatives (POR),
percentage of group members who are from the same village (POV), percentage of
group members who have cooperative relationships with the respondent (POC),
336 farthest geographic distance from the respondent’s house to a peer’s house (FGD), and
a dummy variable for whether any family member is a village official (VO). Higher
POR, POV, or POC show that the borrower has more relatives, friends, or cooperators
among the group members. These variables enable us to investigate whether kinship
or friendship provides any advantage in the monitoring, mutual help, or sanction
process, or if it increases the likelihood of default due to collusion. Yet, we did not
control village dummy variables in this study because all the sample villages had
roughly the same economic, social, and geographic conditions.
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Empirical results
The results of the estimations of repayment behavior are reported in Table IV. From
this Table IV we obtain the following findings.
First, the loan size (AOL) was not correlated with repayment behavior. This result
indicates that a smaller loan was not easier for the borrower to repay. Many borrowers
expressed that they felt a certain reluctance to repay if other members defaulted

Parameter Estimated coefficient SD Significance level

x1: loan and household characteristics

NFM 20.573 * * 0.267 0.031
NFL 0.596 * * 0.284 0.036
AGE 0.036 0.025 0.152
SEX 0.038 0.479 0.937
AOL 0.000 0.000 0.700
x2: household income and income related factors
OCP 0.390 0.357 0.275
FA 20.002 0.088 0.982
BA 0.048 0.065 0.457
OFB 0. 209 0.548 0.702
NWO 0.683 * * 0.251 0.006
HNS 21.076 * * 0.371 0.004
x3: expectation of future loans from RCCs
NOL 20.762 * * 0.315 0.016
NL 20.785 * * 0.363 0.031
RFC 21.874 * * 0.737 0.011
x4: group homogeneity and social ties
POR 0.420 1.273 0.741
POV 4.403 * * 1.030 0.000
POC 1.554 * * 0.670 0.020
FGD 20.003 0.068 0.969
Table IV. VO 1.570 * 0.845 0.063
The estimation results Constant 0.908 1.738 0.601
of group members’
repayment performance Notes: Significant at: *10 and * *5 percent level; log likelihood ¼ 225.398; Nagelkerke R 2 ¼ 0.421
 because assuming others’ debts was troublesome and unequal. In 2008, Chishui RCCs Repayment
began to relieve borrowers of their joint liabilities and we found that many performance of
delinquencies were quickly repaid. This phenomenon showed that strategic defaults
might exist in the survey group. In addition, the coefficients of the household head’s group lending
age (AGE) and borrower’s sex (SEX) were also insignificant. However, having more
family members in the labor force (NFL) significantly improved the timely repayments.
These households usually tend to have higher agricultural output or more non-farming 337
income, which helps them to mitigate vulnerability caused by negative shocks. The
variable of family size (NFM) was negative and significant at a level of 5 percent.
Larger families are likely to include more elderly people and young children, which
negatively affect their ability to repay.
Second, with respect to income and income related factors, the results were mixed.
The variable of having more family members working outside (NWO) only
significantly increased the likelihood of repayment. NWO represents a special group of
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households in rural China. This group usually has higher migrant income, better
education, and a stronger sense of following the law. The dynamic incentives of group
lending may be more effective in inducing these people to make rational investments
and to refrain from strategic defaults. Other income sources, such as owning a larger
FA or BA, owning OFB, or having positive profits on a microloan investment (OCP),
were not shown to significantly improve repayment performance. The estimation
result of the variable of OCP was worth noting. Most borrowers reported that they
were grouped randomly with their preferred members. Low-risk borrowers who are
more likely to make positive profits (high value of OCP), were expected to team up with
other low-risk borrowers. However, there is no evidence that so-called assortative
matching increased the possibility of repayment. One explanation that some low risk
clients chose to default was attributed to strategic default. Many sample households
claimed that they preferred individual lending because it relaxed compulsory liability.
In addition, the dummy variable HNS (whether the family experienced negative income
shocks), was found to have a negative impact at the 1 percent level. This means that
almost all households that suffered from external shocks failed to receive any
monetary help from their peers. Therefore, our estimation results have not provided
clear evidence to support the notion that a higher household income leads to better
repayment performance.
Variables such as the number of outside loan opportunities besides RCCs (NOL),
whether the RCCs were the borrower’s first choice for a loan (RFC), and whether the
borrower needed the RCCs’ loan in the near future (NL) were used to test H1.
Surprisingly, RFC and NL were found to be significantly negative. This means that the
threat of stopping future lending failed to work. To understand the reasons, it is
necessary to consider the background of the RCCs’ program at the survey site. In our
samples, large parts of group loans were used to build rural roads or plant bamboo, not
for sustained investments. Hence, when borrowers could not find new investment
opportunities, their capital demands decreased dramatically. In addition, the high
default rate was supposed to be related to the failure of some subsidized microloan
programs in the 1990s. Households regarded those poverty alleviation loans as gifts from
the government. Therefore, when they received microloans from the RCCs, they treated
the loans as another dole from the government. The variable NOL was also significantly
 CAER negative at the 5 percent level. Clients who had easier access to borrowing from relatives
5,3 or friends had less incentive to minimize their default. Thus, H2 was not proved.
Finally, group member homogeneity and social ties were tested. We found significant
evidence that when a group had a higher percentage of members from the same village
(POV) or had cooperative relationships with the respondent (POC), repayment
performance improved. Therefore, we could draw one conclusion that the more intensive
338 the intra-group communication was, the less repayment difficulties a group might face.
On one hand, group members were willing to support their friends or relatives to cover
repayment problems. On the other hand, they faced much heavier social sanctions in the
case of voluntary default. This could be especially true in the remote and less-developed
villages, where financing sources are limited, and members are more sensitive to being
taunted or rejected by others. Of course, we should pay attention to the possibility of the
problem of endogeneity as well. Households with high creditworthiness might have less
trouble finding peers in their village, which could explain why they usually had higher
repayment capacities. Hence, a better repayment rate may come from the
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creditworthiness of the individuals rather than the mechanisms of peer monitoring

and mutual help as mentioned in our original consideration. Having a family member
working in government agencies (OV) also positively affected the borrower’s repayment
performance. The estimation results were consistent with H2 and H3 that with the
increase of household homogeneity and social ties, the repayment rate also improved.

6. Conclusions
The RCCs’ group lending program has been developing for over ten years in China.
However, most studies have not supported the view that the RCCs successfully
achieved financial sustainability. This paper aimed to shed light on the key factors
behind the failure by applying econometric methods to the case of Guizhou province in
Southwest China. From the collected field data, it is clear that the joint liability
contracts have not achieved a high rate of success as theories claimed. The delinquency
rate in the survey area was as high as 34.7 percent. RCCs failed to develop sustainable
programs in practice.
A theoretical model has been constructed to analyze the repayment behavior of
borrowers. Group members are expected to repay when the costs of default exceed the
benefits. Empirical results show that higher household income did not improve
repayment performance except migrant income, and mechanisms of threatening to
withhold defaulters’ future credit opportunities also did not work. However, group
homogeneity and social ties significantly improved the repayment rate in the survey
site. When a group contained a higher proportion of acquaintances, the chance of
repayment significantly increased. In addition, having a family member working in
government agencies also effectively prevented default.
However, we cannot simply make a conclusion here that strengthening group
homogeneity or social ties is bound to increase the repayment rate. As shown, it is
possible to lead to serious collusion risk. Thus, MFIs have to be careful in discussing
the function of social ties in practice. Our opinion is that group lending is more
attractive for poorer areas with few opportunities for migration and limited access to
finance. Here, trust between households is easier to build and people are more willing
to provide mutual help. On the contrary, in the richer villages, individual action may be
more effective.
 How to overcome the mismatch between group lending and the demand for Repayment
financial services in rural China is still a challenge. Currently, both RCCs and other performance of
MFIs provide limited and rigid menus of microfinance products, but rural individuals
from different areas show diverse demands. They need a broader range of products group lending
with more flexible designs in the form of collateral, credit terms, and price settings, as
well as renegotiation approaches for the defaulting clients. For this reason, we think
the government should encourage a broader participation of all types of MFIs, 339
especially NGOs, which have been successful in serving the unbanked poor in specific
areas and have realized financial sustainability there.
In addition, it is important for MFIs to construct a trustworthy relationship between
themselves and their customers through a better understanding of their clients as well as
by promoting customers’ loyalty. Only in this way, are MFIs likely to maintain
long-term cooperation with their clients and improve their financial profitability.
Moreover, it is critical to choose suitable districts by checking the level of household
assets and their level of financial discipline. Last, but not least, we should recognize that
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a good product design cannot guarantee the success of rural financial reform. Increasing
households’ wealth, building a successful microfinance culture, and reducing the
government intervention in rural financial markets are more important in China.
However, the problem of endogeneity in this paper has remained unsolved for
reasons of sample selection. We failed to control a broader range of unobserved
characteristics that may affect individual repayment decisions. In the future,
a well-designed laboratory experiment should be introduced to test the effectiveness of
joint liability contracts.

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About the authors

Zhang Qinlan is a doctoral student at Laboratory of Rural Development Finance, Department of
Agricultural and Resource Economics, The University of Tokyo. Her current research interests
include microfinance and cooperative finance. Zhang Qinlan is the corresponding author and can
be contacted at: zql629@gmail.com
Yoichi Izumida is a professor at Laboratory of Rural Development Finance, Department of
Agricultural and Resource Economics, The University of Tokyo. His research interests include
agricultural economics and especially rural development finance.

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Appendix

Variables Type Descriptions

AOL Continuous Amount of the loan

NFM Continuous Number of family members
NFL Continuous Number of family members in the labor force
AGE Continuous Age of the household head
SEX Dummy ¼ 1 if the borrower is male; 0 if the borrower is female
OCP Dummy ¼ 1 if the return on the microloan investment can cover the principal and interest
required to pay
FA Continuous Owned farming area, in hectare
BA Continuous Owned bamboo area, in hectare
OFB Dummy ¼ 1 if the family owns off-farm businesses
NWO Continuous Number of family members working outside the home
HNS Dummy ¼ 1 if the family encounters any negative shock, such as sickness or crop losses, or
owning other debts during the period of the loan
NOL Continuous Number of outside loan opportunities besides the RCCs
RFC Dummy ¼ 1 if the RCCs are the respondent’s first choice for a loan
NL Dummy ¼ 1 if the borrower needs a loan from the RCCs in the near future
POR Continuous Percentage of the respondent’s relatives in the group
POV Continuous Percentage of group peers who are from the same village as the respondent
POC Continuous Percentage of group peers who have cooperative relationships with the respondent
FGD Continuous Farthest geographic distance from the respondent’s house to a peer’s house
VO Dummy ¼ 1 if any family member is a village official
group lending
Repayment

Description of variables
Table AI.
341
performance of