Aida Ayupova, Aiym Alenayeva, Bexultan Omirbek, and Zhantore Suleimenov

Review on Risk-Matching in Credit Groups: Evidence from Guatemala paper by Sadoulet and
Carpenter (1999)
The paper presents the investigation about the group formation of borrowers in the relationship
between microfinancing organizations. The thesis of this paper is that even though the literature
often assumes that joint liability will lead groups to form homogeneously in Risk, credit groups
are actually formed heterogeneously even when accounting for matching frictions. Thus, the
main question is to examine risk matching in groups for homogeneity or heterogeneity. As a
result, endogeneity is found to be crucial for borrowers to choose group partners and secondly,
group lending programs can provide insurance for Borrowers. Moreover, the paper is relevant for
the current market of former Soviet Union countries like Kazakhstan and Russia and etc., as the
number of such microfinancing organizations becomes big in the market. The paper helps to see
the behavior of borrowers and also gain some knowledge about matching in the cases of group
borrowing.
Next, the authors give background information on the credit group concept and its prevalence in
developing nations such as Guatemala. They provide evidence from previous studies that support
the effectiveness of risk-matching in credit groups. They note that studies have shown that
individuals who are risk-matched are more likely to repay their loans. To exemplify, Stiglitz
(1990) stated that joint liability and peer pressure forces coordination of choice of projects.
These findings were supported by Ghatah (1995) who also stated that joint liability increases
payment rates. However, none of the past papers address the endogeneity in group formation and
assume that partners matched homogeneously. Thus, according to Wydick (1999), endogeneity
of group formation can explain “mysterious negative relationship” between social ties and the
intra-group insurance provided to prevent default. Thus, this paper fulfills the gap in the
literature by providing new information that groups match heterogeneously.
Section 3 describes the theoretical model used to analyze risk-matching in credit groups. In a
credit group environment, the authors present a model that reflects the dynamic interactions
between individual borrowers and lenders.
The concept is based on the notion that borrowers' ability to repay loans varies, and lenders have
little information about these abilities.
Moving on section 4 describes the data which was taken from a 1995 survey of credit group
members in Guatemala, which included 250 randomly selected groups that borrowed money
 Aida Ayupova, Aiym Alenayeva, Bexultan Omirbek, and Zhantore Suleimenov

from Genesis Empresarial (Guatemalan non-governmental organization that was a part of the
International networks that started lending programs for micro interpreters). Each member of the
group was served individually on characteristics such as his or her principal activity, sales, asset
position, and other sources of credit. Moreover, there were questions about the other members of
the group, for instance if the members know each other before, proximity, mutual help within the
group, they were also asked to give some information on screening, monitoring, and Mutual
Insurance Behavior.
The paper suggests that when choosing the group member, agents should primarily focus on
observed risk (ri) and risk heterogeneity (hi). The paper uses two measures of heterogeneity, and
both of them reject the naive assertion that groups match homogeneously, as some groups
display substantial levels of heterogeneity. This may solely be due to matching frictions, so we
have to empirically test the connection between risk and risk heterogeneity.
In order to test this connection between risk and risk heterogeneity the authors used a different
econometrics model. Firstly, they used the equation with variables for borrowers’s risk
preferences for the prediction of first-best risk and variables for showing the impact of frictions.
For estimation of first best risk and frictions the author used the OLS estimates and CLAD
estimates. In the result, authors find out that the variables like secondary school completion, rich
borrowers, borrowers with restricted sales activities have a positive effect on lower first-best risk
choice. For matching frictions the variables which show the small cities or rural cities, access to
credit sources etc. have stronger effects on matching frictions. By using the F statistics and R
square authors found the poor fit which is the first sign of rejecting the null hypothesis. In order
to avoid the measurement errors the author integrated the instrumental variables and thus, the
author found out that average risks are strongly correlated with borrowers' first best risk and
similar borrowers have similar preferences and matching frictions. By combining the coefficients
from first stage regression for risk and frictions from the OLS estimates then including them to
the second stage regression author found out that the coefficient of risk heterogeneity positive
and different from zero, rejecting the homogeneous matching hypothesis. By running the
robustness specification test and finding the same results authors stated that there is a positive
relationship between a borrower’s preferred risk level and the heterogeneity in the group, which
means that safer borrowers are more likely to match with riskier partners.
 Aida Ayupova, Aiym Alenayeva, Bexultan Omirbek, and Zhantore Suleimenov

Overall, the findings of this paper challenge the common assumption of homogeneous
risk-matching and suggest that borrowers may have incentives to form groups that are more
diverse in terms of risk. Consider the opposite: each agent will want the safest partner possible.
The safest borrowers will match together, the next safest will match together, and so on. In
equilibrium, groups will be homogeneous in risk. Yet, since borrowers have the joint liability,
risky borrowers can get better off from matching with safe borrowers and in turn, safer ones can
receive compensation for extra insurance they provide. In reality it can be seen from Table 8 that
many borrowers offer insurance more frequently than they receive it. It comes from safer
borrowers to their riskier partners. Moreover, Table 9 compares borrowers who are in safe
homogeneous groups with the rest of the borrowers. Surprisingly, these safe groups engage in
more insurance activity even though they are at lower risk. They also have fewer late payments
compared to the full sample, suggesting that screening and monitoring are more important in
these groups. The members of these groups are physically closer together and know each other
before joining the group. They believe that visiting their partners is important for the group.
Additionally, these safe borrowers have less access to credit from friends and money lenders.
This indicates that losing access to credit from Génesis is costly for them. Therefore, they may
need larger transfers to match with different borrowers, which could push them towards similar
matching. However, these borrowers could benefit from self-insurance mechanisms, which
would allow them to match with different borrowers and obtain some surplus (compensation)
from their low risk.
To conclude, the paper tested whether credit groups in Guatemala are homogeneous, as many
studies assume. The survey data consistently shows that some borrowers choose to form groups
heterogeneously even when there are matching frictions. These findings have two important
implications. Firstly, when analyzing the performance of credit groups, it is essential to consider
the endogeneity of group formation. Failure to account for this may lead to incorrect conclusions
when using group characteristics as explanatory variables. Secondly, the analysis suggests that
borrowers may view group lending as a form of insurance. Therefore, it may be necessary to
design better insurance mechanisms within these financial contracts.
Reference:
Carpenter, S., & Sadoulet, L. (1999). Risk-matching in Credit Groups: Evidence from
Guatemala. http://fmwww.bc.edu/RePEc/es2000/1310.pdf