Default Contagion in Group Lending

This paper examines default contagion in group lending schemes with joint liability, a core feature of microfinance. Using unexpected borrower deaths as an exogenous shock, the authors estimate that more than two-thirds of default in one of Chile’s largest microfinance institutions is driven by contagion effects, whereby one borrower’s non-payment reduces repayment by group members. Following the COVID-19 pandemic, contagion declined, partly due to the exit of high-risk borrowers. The lender later introduced a policy allowing loan officers to remove struggling borrowers from joint liability while maintaining group membership; the authors provide evidence that this policy effectively reduced contagion.