Keywords: Microfinance, Social Networks, Intertemporal Consumption.
In this paper we analyze the role of peer solidarity in fostering productive investments in
the context of microfinance. When there is asymmetric information between lenders and borrowers and
loans are not collateralized, borrowers may divert loans towards current consumption rather than investing
in production. We assume that solidarity is accorded by a network of individuals close enough to the
borrower (peers) so as to share private information about hidden effort in the productive project. The
model shows that peer solidarity might have contrasting effects on the effort in the productive investment.
On the one hand, since solidarity transfers are contingent on the effort, they increase borrower's incentive
to invest. On the other hand, solidarity tranfers decrease the marginal utility of future consumption at the
expense of productive investment. The predictions of the model are tested on households enrolled in micro-
lending programs who were surveyed in Bangladesh by the World Bank during the period 1991-1992.
Empirical findings suggest a positive relationship between potential solidarity of the network of relatives
and the share of loans invested in productive activities.