Reducing the Strain of Group Microloans with a Small Collateral Requirement

This can put relationships at risk and add pressure and strain to individual borrowers. Moreover, it opens the door for freeriding (moral hazard), which may deter the most trustworthy community members from joining credit groups altogether. An experimental game conducted among existing credit group members of the NGO Vision Fund Tanzania (VFT) tested a hybrid alternative microfinance loan that mixes elements of a no-collateral group loan and individual loans that require collateral. The study focused on whether this kind of collateral could impact the mentioned moral hazard and how it affects the number of people seeking loans. The impacts found on effort, credit demand, and defaults imply a new opportunity to benefit both microfinance lenders and their borrowers. The experimental game simulated a VFT loan for a sunflower oil seed crop, a profitable but risky crop in the study area. The study participants were 305 small-scale farmers from 70 VFT credit groups in the area around Singida, Tanzania. Each participant completed a simple activity to earn Tsh 1,000 of real money to use in the game, and total payouts averaged Tsh 5,300 ($3.32). The study tested three loan contracts: an individual loan, a standard group loan, and a hybrid of individual and joint-liability loans with a 20% individual collateral requirement. The results showed that adding the small collateral requirement to group loans significantly increased individual effort in the shared sunflower crop, with a 5% increase in effort. Imposing the small individual collateral requirement on its own reduced loan defaults by between 15 and 20 percent.