Optimal group size with joint liability group lending strategy

Purpose – This paper aims to offer a theory on optimal group size. To overcome the problems of institutional credit facilities to the poor and marginal people, Joint Liability Group Lending (JLGL) is often considered as a better option. However, the literature in the field is surprisingly silent about the issue of group-size. This paper tries to fill the vacuum in a theoretical framework. Design/methodology/approach – Using a standard theoretical model, this paper shows that even with costless peer monitoring, there exists an upper bound on the size of group, and this upper bound is exactly pinned down by the strength of the social sanction. Findings – This paper shows that under reasonable specification of effort cost, as group size increases, both optimal cooperative effort level and the deviation incentive from that effort level rise monotonically for any individual borrower. Thus, given the strength of social sanction, the rising incentive for deviation uniquely determines the optimal group size even in absence of free riding in peer monitoring. Research limitations/implications – The theoretical results derived in the paper require empirical verification which is, however, tricky because of the problems associated with quantifying social sanctions. Practical implications – This paper argues that the group size should be larger in more integrated communities which have better social cohesion among its members. Originality/value – This paper shows that, for a given extent of joint liability the borrowers need to bear, the group size in joint liability group lending should be designed according to the strength of social sanction prevailing in the society to achieve social efficiency.