Solidarity lending is a lending

Loan

A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....

 practice where small groups borrow collectively and group members encourage one another to repay. It is an important building block of microfinance

Microfinance

Microfinance is the provision of financial services to low-income clients or solidarity lending groups including consumers and the self-employed, who traditionally lack access to banking and related services....

.

How it Works

Solidarity lending takes place through ‘solidarity groups’. These groups are a distinctive banking distribution channel

Distribution (business)

Product distribution is one of the four elements of the marketing mix. An organization or set of organizations involved in the process of making a product or service available for use or consumption by a consumer or business user.The other three parts of the marketing mix are product, pricing,...

 used primarily to deliver microcredit

Microcredit

Microcredit is the extension of very small loans to those in poverty designed to spur entrepreneurship. These individuals lack collateral, steady employment and a verifiable credit history and therefore cannot meet even the most minimal qualifications to gain access to traditional credit...

 to poor people. Solidarity lending lowers the costs to a financial institution related to assessing, managing and collecting loans, and can eliminate the need for collateral

Collateral (finance)

In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...

. Since there is a fixed cost

Fixed cost

In economics, fixed costs are business expenses that are not dependent on the level of goods or services produced by the business. They tend to be time-related, such as salaries or rents being paid per month, and are often referred to as overhead costs...

 associated with each loan delivered, a bank that bundles individual loans together and permits a group to manage individual relationships can realize substantial savings in administrative and management costs.

In many developing countries the legal system offers little, if any support for the property rights of poor people. Laws related to secured transactions – a cornerstone of Western banking – may also be absent or unenforced. Instead, solidarity lending levers various types of social capital

Social capital

Social capital is a sociological concept, which refers to connections within and between social networks. The concept of social capital highlights the value of social relations and the role of cooperation and confidence to get collective or economic results. The term social capital is frequently...

 like peer pressure, mutual support and a healthy culture of repayment. These characteristics make solidarity lending more useful in rural villages than in urban centres where mobility is greater and social capital is weaker.

Efforts to replicate solidarity lending in developed countries have generally not succeeded. For example, the Calmeadow Foundation tested an analogous 'peer lending' model in three locations in Canada: rural Nova Scotia and urban Toronto and Vancouver during the 1990s. It concluded that a variety of factors—including difficulties in reaching the target market, the high risk profile of clients, their general distaste for the joint liability requirement, and high overhead costs—made solidarity lending unviable without subsidies. However, debates have continued about whether the required subsidies may be justified as an alternative to other subsidies targeted to the entrepreneurial poor, and VanCity Credit Union

Vancity

Vancouver City Savings Credit Union, commonly referred to as Vancity, is a member-owned financial institution in Vancouver, British Columbia and the largest English-speaking credit union in Canada...

, which took over Calmeadow's Vancouver operations, continues to use peer lending.

How it is Distinctive

Tapping social capital to lend money is not new to microfinance

Microfinance

Microfinance is the provision of financial services to low-income clients or solidarity lending groups including consumers and the self-employed, who traditionally lack access to banking and related services....

. Earlier precedents include the informal

Informal economy

The informal sector or informal economy as defined by governments, scholars, banks, etc. is the part of an economy that is not taxed, monitored by any form of government, or included in any gross national product , unlike the formal economy....

 practices of ROSCAs

Rotating Savings and Credit Association

A Rotating Savings and Credit Association or ROSCA is a group of individuals who agree to meet for a defined period of time in order to save and borrow together...

 and the bonds of association

Bond of association

The bond of association or common bond is the social connection among the members of credit unions and co-operative banks. Common bonds substitute for collateral in the early stages of financial system development...

 used in credit unions. In India, the practice of self-help group banking

Self-help group (finance)

A self-help group is a village-based financial intermediary usually composed of 10–20 local women. Most self-help groups are located in India, though SHGs can also be found in other countries, especially in South Asia and Southeast Asia....

 is inspired by similar principles.

However, solidarity groups are distinctly different from earlier approaches in several important ways.

First, solidarity groups are very small, typically involving 5 individuals who are allowed to choose one another but cannot be related. Five is often cited as an ideal size because it is:

• small enough to ensure a maximum level of joint responsibility and discourage free riders
  Free rider problem
  In economics, collective bargaining, psychology, and political science, a free rider is someone who consumes a resource without paying for it, or pays less than the full cost. The free rider problem is the question of how to limit free riding...
  
  , and
• large enough to prevent the misfortune or incompetence of one person from causing the group to collapse.

Much evidence has also shown that social pressure is more effective among women than among men. The vast majority of loans using this methodology are delivered to women.

Learning from the failure of the Comilla Model

Comilla Model

The Comilla Model was a rural development programme launched in 1959 by the Pakistan Academy for Rural Development...

 of cooperative credit piloted by Akhtar Hameed Khan

Akhtar Hameed Khan

Akhtar Hameed Khan was a Pakistani development activist and social scientist credited for pioneering microcredit and microfinance initiatives, farmers' cooperatives, and rural training programmes in the developing world. He promoted participatory rural development in Pakistan and other developing...

 in the 1950s and '60s, Grameen Bank

Grameen Bank

The Grameen Bank is a microfinance organization and community development bank started in Bangladesh that makes small loans to the impoverished without requiring collateral...

 and many other microcredit

Microcredit

Microcredit is the extension of very small loans to those in poverty designed to spur entrepreneurship. These individuals lack collateral, steady employment and a verifiable credit history and therefore cannot meet even the most minimal qualifications to gain access to traditional credit...

 institutions have also taken an assertive approach to targeting poor women and excluding non-poor individuals entirely.

A major reason for the prior failure of credit cooperatives in Bangladesh was that the groups were too big and consisted of people with varied economic backgrounds. These large groups did not work because the more affluent members captured the organizations.

Grameen Bank

An early pioneer of solidarity lending, Dr. Muhammad Yunus

Muhammad Yunus

Muhammad Yunus is a Bangladeshi economist and founder of the Grameen Bank, an institution that provides microcredit to help its clients establish creditworthiness and financial self-sufficiency. In 2006 Yunus and Grameen received the Nobel Peace Prize...

 of Grameen Bank

Grameen Bank

The Grameen Bank is a microfinance organization and community development bank started in Bangladesh that makes small loans to the impoverished without requiring collateral...

 in Bangladesh

Bangladesh

Bangladesh , officially the People's Republic of Bangladesh is a sovereign state located in South Asia. It is bordered by India on all sides except for a small border with Burma to the far southeast and by the Bay of Bengal to the south...

 describes the dynamics of lending through solidarity groups this way:

... Group membership not only creates support and protection but also smooths out the erratic behavior patterns of individual members, making each borrower more reliable in the process. Subtle and at times not-so-subtle peer pressure keeps each group member in line with the broader objectives of the credit program. … Because the group approves the loan request of each member, the group assumes moral responsibility for the loan. If any member of the group gets into trouble, the group usually comes forward to help.

The Grameen approach uses solidarity groups as its primary building block. However, responsibility for delinquent loans is handled by the elected leaders of a larger, village-level group called a ‘centre’ composed of eight solidarity groups. Because all the members are from the same village and loan payments take place during the centre meeting, the principle of using social capital for leverage is not compromised; the only difference is that all the members of the centre are collectively responsible for unpaid loans.

Many microcredit

Microcredit

Microcredit is the extension of very small loans to those in poverty designed to spur entrepreneurship. These individuals lack collateral, steady employment and a verifiable credit history and therefore cannot meet even the most minimal qualifications to gain access to traditional credit...

 institutions use solidarity groups essentially as a form of joint liability. That is, they will take any action practical to collect a seriously delinquent loan not just from the individual member, but from any member of the solidarity group with the capability to repay it. But Yunus has always rejected this concept, arguing that whatever moral responsibility may pertain among group members, there is no formal or legal “… form of joint liability, i.e. group members are not responsible to pay on behalf of a defaulting member.”

Application

Solidarity lending is widespread in microfinance today, particularly in Asia. In addition to Grameen Bank, major practitioners include SEWA

SEWA

The Self-Employed Women's Association of India is a trade union for poor, self-employed women workers in India. SEWA was founded in 1972 by the noted Gandhian and civil rights leader Dr Ela Bhatt. SEWA's main office is located in Ahmedabad, Gujarat, and it works in several states of India. SEWA...

, Bank Rakyat Indonesia

Bank Rakyat Indonesia

Bank Rakyat Indonesia or PT. Bank Rakyat Indonesia , , is one of the larger banks in Indonesia. It specialises in small scale and microfinance style borrowing from and lending to its approximately 30 million retail clients through its over 4,000 branches, units and rural service posts...

, Accion International

Accion International

ACCION International is a nonprofit organization that supports microfinance institutions in their work to provide financial services to low-income clients. ACCION provides management services, technical assistance, debt and equity investment and training to microfinance institutions and...

, FINCA

Finca

Finca is a board game published by Hans im Glück. Players collect fruit by stepping around a windmill and then selling the fruit in specific combinations to the various towns on the game board.The game was nominated for the Spiel des Jahres in 2009....

, BRAC

BRAC (NGO)

BRAC, based in Bangladesh, is the world's largest non-governmental development organization. Established by Sir Fazle Hasan Abed in 1972 soon after the independence of Bangladesh, BRAC is present in all 64 districts of Bangladesh, with over 7 million microfinance group members, 37,500 non-formal...

 and SANASA. The Calmeadow Foundation was another important pioneer.

The Microbanking Bulletin tracks solidarity lending as a separate microfinance methodology. Of 446 microfinance institutions worldwide that it was tracking at the end of 2005, 39 lent only through this method, while another 205 used a mix of solidarity and individual lending. The average loan balance outstanding at solidarity lenders was $109 (19% of local gross national income

Gross National Income

The GNI consists of: the personal consumption expenditures, the gross private investment, the government consumption expenditures, the net income from assets abroad , and the gross exports of goods and services, after deducting two components: the gross imports of goods and services, and the...

), compared to $1,024 (61% of local gross national income

Gross National Income

The GNI consists of: the personal consumption expenditures, the gross private investment, the government consumption expenditures, the net income from assets abroad , and the gross exports of goods and services, after deducting two components: the gross imports of goods and services, and the...

) among individual lenders. This shows not only that solidarity lenders are meeting the needs of a significantly poorer market segment, but also that they are doing it in significantly poorer countries.

In Costa Rica

Costa Rica

Costa Rica , officially the Republic of Costa Rica is a multilingual, multiethnic and multicultural country in Central America, bordered by Nicaragua to the north, Panama to the southeast, the Pacific Ocean to the west and the Caribbean Sea to the east....

, many companies enable their employees to organize Asociaciones Solidaristas (Solidarism Associations), which enables them to create saving funds, loans, and financial activities (for example managing the company's coffee shop) with financial support from the company.Movimiento Solidarista Costarricense's website

Criticisms

Solidarity lending has clearly had a positive impact on many borrowers. Without it, many would not have borrowed at all, or would have been forced to rely on loan sharks. However, it has been the subject of much criticism. A recent survey of the empirical research concludes that the search for alternative approaches must continue, and highlights problems such as “borrowers growing frustrated at the cost of attending regular meetings, loan officers refusing to sanction good borrowers who happen to be in ‘bad’ groups, and constraints imposed by the diverging ambitions of group members."

Efforts to ensure that all members of solidarity groups are equally poor may not always improve group performance. Greater socio-economic diversity "means that group members' incomes are less likely to vary together, and thus group members' ability to insure each other increases". The solidarity lending approach, which excludes less-poor borrowers, was adopted in large part because of a view that the more inclusive cooperative 'bond of association' had failed in Bangladesh (see the Comilla Model

Comilla Model

The Comilla Model was a rural development programme launched in 1959 by the Pakistan Academy for Rural Development...

). But the founder of Bangladesh's credit cooperatives, Akhter Hameed Khan documented that the Model's practices contravened two fundamental credit union operating principles: independence from government intervention, and local financial self-reliance. The case that the 'inclusive' approach to organizational development used by the Comilla Model accounts for its failure has not been made.

While poverty-targeting has had many successes, social solidarity is not solely a tool for the lending institution – it can also be used by borrowers. A loan ‘strike’, if it gains the sympathy of a large number of borrowers, can lead to a rapid and highly unstabilizing escalation in delinquencies. It was this type of circumstance that led in 1998, to the rapid escalation of delinquency at Grameen Bank that resulted in the redesign dubbed ‘Grameen II’.

The photo above—of a group of women seated in rows on the ground before a male NGO-officer who sits in a chair processing their payments—encapsulates another common critique. Solidarity groups may be composed entirely of women, but the staff who decide when and if they receive financial services are often dominated by males.