Microlending is growing in Eastern Europe, Russia and China as a flexible means of widening access to financial services, both to help alleviate poverty and to encourage private-sector activity. We describe mechanisms that allow these programmes to successfully penetrate new segments of credit markets. These features include direct monitoring, regular repayment schedules, and the use of non-refinancing threats. These mechanisms allow the programmes to generate high repayment rates from low-income borrowers without requiring collateral and without using group lending contracts that feature joint liability.JEL classification: D82, L14, O12, O17.

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This paper develops an adverse selection model where peer group systems are shown to trigger lower interest rates and remove credit rationing in the case where borrowers are uninformed about their potential partners and ex post state verification (or auditing) by banks is costly. Peer group formation reduces interest rates due to a ‘collateral effect’, namely, cross subsidisation amongst borrowers acts as collateral behind a loan. By uncovering such a collateral effect, this paper shows that peer group systems can be viewed as an effective risk pooling mechanism, and thus enhance efficiency, not just in the full information set up.

Microfinance institutions deliver financial services for low-income individuals via innovative techniques. This paper first explains the nature and scope of such techniques, and then delivers an overview of recent trends. In conclusion, the paper calls for international donors' and local governments' support in at least three main areas, so that recent innovations can further enable microfinance institutions to meet both their selfsustainability and social objectives.