The impact of joint liability lending on leveraging social capital

Abstract

Joint liability lending, which leverages borrowers' social ties, is crucial for providing credit access to the poor. However, scholars worry that these lending practices might undermine the social capital they utilize, hindering its development as people become wary of such arrangements. While these concerns have persisted, they lack rigorous analysis. Using a game-theoretic framework, we show that when reciprocity motivations are strong, joint liability lending can trigger social sanctions among borrowers, eroding their social capital. We test these theoretical predictions using data from the China Household Finance Survey. Our analysis reveals that variations in loan amounts unexplained by observable borrower characteristics, which serve as proxies for the use of joint liability in lending decisions, negatively impact borrowers' expenditures on maintaining social ties — our measure of social capital. These findings suggest that financial institutions should carefully implement joint liability lending to avoid damaging community social capital while serving the poor.