Are SHG Loans Demand Constrained in Backward Areas?

Group lending has been less successful in backward areas compared to more advances area. In this chapter, we argue that group formation eases the supply constraints on loan as the banks’ probability of getting back loan increases, but as expected joint liability payment of the risky borrowers increases their demand for loans. As a result, it is possible that the equilibrium level of loans declines if the proportion of risky borrowers is disproportionately high in any area and their probability of success is low. We argue that people living in backward areas are more risk prone due to low level of infrastructural support such as road, electricity, water supply, healthcare centres and low level of educations, and hence, the result can be used to explain why group lending might have been less successful in backward areas. In backward regions, the proportion of safe borrowers and the probability of success of projects are expected to be low. Our model with adverse selection shows that lending under group contracts in that case may come down in backward areas. We prove that if the conditions are such that both proportion of safe borrowers and probability of success of projects are low, demand for loans may come down outweighing the favourable effects of increase in loan availability due to group contracts. The demand side argument is the innovation we have introduced to show that group lending may not necessarily lead to higher lending.