Group Lending in Ghana - 5 Ways to do it Right
In August 2021, 52 MFIS in Ghana participated in a survey launched by GHAMFIN, in collaboration with Fluid (fluidfinance.co), providing information on the share of group loans within their overall loan portfolio. The results showed that an overwhelming 41% of respondents did not use group loans at all and, overall, 62% percent of respondents disbursed less group loans than individual loans.
Other African microfinance markets display similar trends. In Kenya, a study revealed that only 25% of all microcredit issued is extended to groups. This low adoption of group lending contrasts success stories like that of the Grameen Bank, which popularized the usage of joint-liability microcredit in Bangladesh.
In Ghana, our research on microfinance has shown that group lending is a polarizing topic among MFIs. Some institutions have lauded group lending as a cost-effective and secure way to issue credit. Others cited “horror stories” related to group loans that have discouraged the usage of the practice in their operations.
Why should MFIs make effective use of group lending in Ghana?? We provide some answers to this key question for microfinance investors.
Group Loans and their Purpose
To understand the purpose of group lending, we have to study the history of the practice. The Grameen Bank introduced group loans as a way to cut costs through scale economies. Later, the famous Bangladeshi firm discovered that group-lending generate efficiencies in customer screening, monitoring and debt collection.
MFIs have two main reasons for employing the group lending methodology. The first is that group lending reduces the risk of loan failure due to moral hazards from customers. When customers self-select members to form a group, they are expected to avoid choosing individuals that are unlikely to repay their loan obligations. The second reason is that after the loan is disbursed, customers that share social bonds are likely to enforce debt repayment through peer pressure and monitoring, therefore saving the MFI monitoring costs.
However, group lending also presents some disadvantages. It requires additional effort to form groups, train and supervise them throughout the loan repayment cycle. Additionally, group loans present the risk of “domino defaulting”. If one group member defaults, then the entire group might follow suit due to losing the incentive of future credit.
5 Ways to Effective Group Lending
1 — Targeting the right people
The fundamental tenet of group lending is leveraging social bonds between borrowers of a similar background to enforce loan repayment.
For that reason, finding communities fit for group lending is the most important step to issue jointly liable credit. A study on the topic in South Africa has shown that MFIs should target close-knit communities, like villages or cooperatives, to extend loans. It is important to note, however, that relatives should not be in the same groups as they will be less likely to impose social sanctions on family members.
Borrower mobility is also an important factor to consider. Individuals that can easily leave the place where they have been issued the loan are more likely to drop out and default in hard times.
It has also been found that borrowers with limited alternative sources of credit are less prone to defaults as they rely on the MFI for future loans. For that reason, women tend to be better repayers than men since they have limited sources of financing and choose safer business ventures.
When lending to groups with similar business activities, MFIs should assess the business risks of the borrowers. In Ghana, close attention should be paid to factors such as seasonality when lending to groups of the same activity.
2 — Encouraging Borrowers to Save
Promoting savings products to borrowers decreases their likelihood of defaulting. With higher savings, borrowers are less tempted to divert loan funds for personal use. Saving deposits also serve as an “organic collateral” for the MFI that can be used to repay an underperforming loan. Lastly, creating savings accounts for borrowers is a way to retain customers for MFIs as it encourages a long lasting relationship between parties. For success, MFIs have to remember that saving is difficult for economically pressured communities and address the barriers preventing customers from saving.
3 — Keeping Group Members Informed
In Ghana, some MFIs have cited the “bad group leader” problem as a deterrent to engage in group lending. This problem occurs when a group member with influence diverts group repayments to their personal benefit. This is prevalent in groups where hierarchical dynamics take place. Junior group members trust a senior member with their repayments only to find out that their funds had been misappropriated at loan maturity.
Moral hazards of this nature can be mitigated by ensuring that borrowers remain informed on their group’s performance on a frequent basis. MFIs can leverage frequent meetings with group members to ensure proper communication. However this can be costly for MFIs due to traveling costs.
Alternatively, MFIs can employ technological solutions such as phone alerts to notify group members. Fluid is currently working with MFIs in Ghana to develop systems to manage customers remotely.
4 — Promoting Larger Borrowers
Group lending cycles involve providing higher loan amounts to borrowers as they successfully repay previous facilities. As the borrower develops their business, they need more capital for growth. However, this practice presents several risks to MFIs as large borrowers become less suited for group lending.
Group loans are designed to be provided to individuals of similar socioeconomic characteristics. Larger borrowers tend to disrupt group dynamics as newer/less successful members might be unwilling to guarantee loan amounts higher than their own.
Larger loan amounts also induce riskier behaviour in borrowers, thus compromising the reliability of the group.
To solve this issue, MFIs should develop “promotion programs” that move large borrowers from groups to individual lending schemes. For Tier-2/3 MFIs in Ghana, it is also recommended to create referral programs funnelling large borrowers to commercial or rural banks.
5 — Frequent Contact Points
Frequent group meetings and repayments have often been linked to better loan performance. In impoverished communities, borrowers will be constantly inclined to spend repayments for personal use. As such, frequent touch points can help reduce the risk of fund diversion in groups.
Group borrowers tend to be less effective at monitoring their peers than enforcing debt repayment. This is because peer monitoring requires constant effort from group members at the expense of business development or family care. Group members will be much more active when they are aware a fellow member underperforms to avoid the risk of having to cover their debt. Leveraging frequent group meetings to announce performance results is a good way to ensure that group members remain in good standing as it generates peer pressure.
For MFIs, frequent group meetings will come at a cost since they require travel. However these expenses can be offset by using group meetings to sell other financial products to customers (long-term savings, insurance, etc.).
Group Lending is a practice that makes capital accessible to the most under-privileged communities in the country. With the correct strategy, it can yield repayment rates as high as 95% in Ghana. Fluid is currently working with MFIs in Ghana to deploy technology systems to scale group lending schemes. If you are interested in learning more, visit fluidfinance.co