Ricerc@Sapienza

Credit institutions often refuse to lend money to small firms. Usually, this happens
because small firms are not able to provide collateral to lenders. Moreover, given the
small amount of required loans, the relative cost of full monitoring is too high for
lenders. Group lending contracts have been viewed as an effective solution to credit
rationing of small firms in both developing and industrialized countries. The aim of
this paper is to highlight the potential of group lending contracts in terms of credit
risk management. In particular, this paper provides a theoretical explanation of the
potential of group lending programs in screening good borrowers from bad ones to
reduce the incidence of non-performing-loans (NPL). This paper shows that the success
of firms involved in selected group lending programs is due to the fact that cosignature
is an effective screening device: more precisely, if lenders make a proper use
of co-signature to screen good firms from bad ones, then only firms that are good
ex-ante enter group lending contracts. So, the main argument of this paper is that
well designed group lending programs induce good firms to become jointly liable,
at least partially, with other good firms and discourage other – bad-firms to do the
same. Specifically, co-signature is proven to be a screening device only in the case of a
perfectly competitive bank sector.