Lending to Agribusinesses in Zambia

key mechanisms used by these institutions to achieve high repayment rates, namely, peer
selection, peer monitoring, dynamic incentives, regular repayment schedules and the use
of collateral substitutes.

Peer selection and peer monitoring result from the use of group lending contracts
which entail joint liability for loans by the borrowers, thus giving an incentive for self-
sorting among the borrowers as they try to avoid partnering with risky borrowers. This, in
a sense, shifts some of the monitoring burden to the borrowers themselves and can
actually help the lender minimize the adverse selection effect resulting from asymmetric
information. It is also one way of ensuring that borrowers exercise prudence in the use of
funds so that the likelihood of repayment is enhanced (Stiglitz 1990). On the other hand,
other studies (Madajewicz 2003) have found that this assortative matching effect of group
lending contracts only works with the poorer borrowers and does not hold for the
wealthier among the poor. Nevertheless, group lending has been used even in developed
nations such as the United States, though at a smaller scale (Prescott 1997).

The third mechanism, dynamic incentives, refers to a lending and information
generation mechanism in which the lender starts with very small loans and gradually
increases the loan size as customers demonstrate reliability (Amendariz and Morduch
2005). Morduch (1999) finds that through the repeated nature of the interactions with
borrowers and the threat to cut off lending when loans are not repaid, dynamic incentives
can be exploited by microfinance institutions as a mechanism for securing high
repayment rates. He further finds that the incentives are enhanced further if borrowers
can anticipate the stream of increasingly larger loans.

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