Problem
1. "The only reason why group lending methodologies in microfinance can potentially enhance efficiency is that it lowers transaction costs." Is this statement true? Carefully explain your answer.
2. Assume the following timing: First a loan is made; then returns accrue to the borrowers; next, monitoring takes place, where borrowers assess the nature of their peers' returns (i.e., they verify whether their peers are reporting their returns accurately); finally, borrowers produce a fully verifiable report on their partners' true return realizations. In this setting, the population to which the break-even bank is considering extending loans is identical. The bank knows that any borrower in this economy can invest an amount I and get a gross return of y with certainty, but it is unable to verify borrowers' returns once they've been realized. The gross interest rate on loans is R; thus, when a project yields a return, a borrower can either repay R or lie (e.g., claim that she is unable to repay). If a borrower lies and is found out, she receives a sanction B.
a. Explain what happens when B < r under individual lending contracts without monitoring.>
b. Now suppose that the bank lends to pairs of borrowers under a joint liability clause, and suppose that the borrowers can potentially verify each others' return realizations when either borrower states that she cannot repay. Monitoring return realizations costs k < b>< r. if the group defaults, its members lose future access to credit from the bank. this will incur a loss equivalent to c in present value terms to each member, where c> k. Assume for simplicity that y > 2R. Can potential borrowers obtain a loan in this case? Relate your answer to your interpretation of B.
The response should include a reference list. Double-space, using Times New Roman 12 pnt font, one-inch margins, and APA style of writing and citations.