Game theoretic approaches in lending to the poor

Abstract

Abhijit Banerjee and Esther Duflo were jointly awarded the Nobel Memorial Prize in Eco nomic Sciences in 2019 for their experimental approach to alleviating global poverty. Their works in this field have been summarized in the book named “Poor Economics” authored by them. One of the areas of focus in their work was their empirical study on how lend ing happens to poor borrowers. One of the methods discussed by them was group lending through various microfinance institutions. This method has become a popular practice in many developing countries to address the issue of lending for poor borrowers. Instead of at tempting to borrow individually, people organize into self-help groups that collectively take out loans; all group members are responsible for paying them back. This arrangement al lows financial institutions to rely on information advantages among group members, rather than on financial collateral, to mitigate information asymmetries between lenders and bor rowers. In our project, using the empirical study done by Banerjee and Duflo in their book “Poor Economics”, we have studied and formed a game theoretic model of lending. For that, we first understood the setting and formed variables accordingly. Using those vari ables, we formulated our game between borrower and lender and computed the payoff of the borrowers in case of individual lending and group liability lending. We then compared payoff of borrowers under individual lending and group liability lending when using mul tiple strategies. Finally, using the game theoretic model which we had created for group liability lending, we found the optimal size of group which maximizes the social payoff of the members present in the group Keywords: microfinance, group lending, group liability, strategies, social payoff