Suppose the loan amount needed for an investment is $300, and each loan is associated with a cost of $50 for the bank. The gross return on the investment is $600, but the bank cannot verify whether the project was successful or whether it failed, and has no way to enforce repayment.
(a) What is the minimum amount of collateral necessary to achieve repayment, assuming all collateral is lost when the borrower runs away with the profits?
(b) Now suppose that the bank offers a group contract. It will lend to a group of 2 agents and it imposes a "joint responsibility" clause and by paying an effort cost of $30 a borrower can monitor her partner. Will this improve the situation? Why or why not?
(c) Suppose the bank gave up and the only possibility to take out a loan in the village is the local money lender. Describe two ways he could make borrowers repay even though they have collateral.