Microfinance is characterised by group lending.

The process of group lending has been found superior because it can reduce the problem of moral hazard and adverse selection (Gine Xavier and D. Karlan,2007). By making a group of clients liable for each others loans, the lender can ensure that the borrowers have an incentive to include only the trustworthy individuals. At the same time clients in a group face peer pressure and not just legal pressure to repay the loans. So, group lending effectively shifts the responsibility of choosing good borrowers from the lender to the clients (Ghatak, Maitreesh and Timothy W. Guinnane, 1999). In recent years, however, some microlenders, such as the Association for Social Advancement (ASA) in Bangladesh or the Bank Rakyat Indonesia (BRI), have expanded rapidly using individual liability loans. Others, like Bancosol in Bolivia, have converted a large share of its group liability portfolio into individual liability lending. Even the Grameen Bank in Bangladesh has recently relaxed the group liability clause in the Grameen II programme. The shift to individual lending is also done by many other small and medium lenders (Gine Xavier and D. Karlan,2007). Now the question arises is that whether there are some disadvantages with group lending so that the lenders are shifting from group to individual kind of system or is it because this shift is a mere business policy of making the system more profitable. There are some disadvantages that have been identified by some researchers. First, clients dislike the tension caused by group liability. Second, bad clients can free ride off of good clients causing default rates to rise. In other words, a client does not repay the loan because she believes that another client will pay it for her, and the bank is near indifferent because it still gets its money back. Third, group liability is more costly for clients that are good because they are often required to repay the loans of their peers. This may lead to higher dropout and more difficulty in attracting new clients. Finally, as groups mature, clients typically diverge in their demand for credit. Heterogeneity in loan sizes can result in tension within the group as clients with smaller loans are reluctant to serve as a guarantor for those with larger loans (Karlan, Dean, 2009; Harper, Malcom, 2007). In a study in a bank (Green Bank) in Philippines Gine Xavier and Dean S. Karlan found that shifting to an individual lending kind of system did not have any impact on the repayment rate. It did however increase the number of individual borrowers. Chatterjee and S. Sarangi (2004) with the formation of some propositions and models argued that if group formation is a costly affair, then joint liability lending programs may not alleviate moral hazard problems. Due to the group formation costs such programs may not be able to reach the poorest sections of society or some safe borrowers may get excluded from the program.

The debate between group lending and individual lending takes the issue from the supply side of microfinance. The main issues of concern seem to be the viability and profitability of the micro finance institutions. But, more important issue is whether individual lending could effectively reach the poorest of the poor of the society with credit and provide them with loans that they can use effectively and repay without too much burden.

1. Ghatak, Maitreesh and Timothy W. Guinnane (1999): The Economics of Lending with Joint Liability: Theory and Practice, The Journal of Development Economics, vol60. 2. Chatterjee, Prabirendra and Sudipta Sarangi (2004): Social Identity and Group Lending, http://www.bus.lsu.edu/economics/papers/pap04_01.pdf. Accessed on: 12th April, 2011. 3. Xine, Xavier and Dean S. Karlan (2007): Group versus Individual Liability: A Field Experiment in the Philippines 4. Harper, Malcolm (2007): Whats wrong with groups? in Thomas Dichter and Malcolm Harper (ed.) Whats wrong with microfinance, Practical Action Publishing, Warwickshire,2007. 5. Karlan, Dean (2009) : Strength in Numbers?, Microfinance insights, September-October, 2009.