Screening by the company you keep: Joint liability lending and the peer selection effect

We look at an economic environment where borrowers have some information about the nature of each other's projects that lenders do not. We show that joint-liability lending contracts, similar to those used by credit cooperatives and group-lending schemes, will induce endogenous peer selection in the formation of groups In a way that the instrument of joint liability can be used as a screening device to exploit this local information. This can improve welfare and repayment rates if standard screening instruments such as collateral are unavailable.