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Social connections and group banking*

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     I thank my advisors Abhijit Banerjee, Dora Costa, Esther Duflo and Sendhil Mullainathan for their guidance throughout this research. I thank eight anonymous referees, four editors and Niels Hermes, Robert Lensink. I also thank Alexander Aganine, Beatriz Armendariz de Aghion, Robin Burgess, Ben Jones, Leigh Linden, Norman Loayza, Cade Massey, Jonathan Morduch, Ashok Rai, Laura Schechter, Richard Thaler, Ashley Timmer, Chris Udry, Justin Wolfers and Eric Zitzewitz and participants at the 2006 Groningen conference on microfinance, 2001 NEUDC, 2001 LACEA PEG/NIP and 2004 ASSA, and at seminars at Harvard/M.I.T., Princeton, Yale, Maryland, Texas, Williams, Johns Hopkins, UC-Irvine, Berkeley, UCLA, University of Washington, Michigan, Georgetown, Miami and the Univeristy of Natal, South Africa. Last, but not least, thanks to Iris Lanao, Aquiles Lanao and Morena Lanao from FINCA and my field team, particularly Alcides Medina, Fatima Oriundo and Jeny Yucra. The research reported herein was supported by the SSRC, the Russell Sage Foundation, the M.I.T. George Shultz Fund and the Center for Retirement Research at Boston College pursuant to a grant from the Social Security Administration. All views and errors are mine.

Abstract

Lending to the poor is expensive due to high screening, monitoring and enforcement costs. Group lending advocates believe lenders overcome this by harnessing social connections. Using data from FINCA-Peru, I exploit a quasi-random group formation process to find evidence of peers successfully monitoring and enforcing joint-liability loans. Individuals with stronger social connections to their fellow group members (i.e., either living closer or being of a similar culture) have higher repayment and higher savings. Furthermore, I observe direct evidence that relationships deteriorate after default, and that through successful monitoring, individuals know who to punish and who not to punish after default.

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