This blog series is just more evidence that the microfinance industry is currently united around a common concern: avoiding over-indebtedness. Whether to protect the social impact on customers or the institutional viability of MFIs, over-indebtedness is crucial to all parties involved.
Still the most fundamental questions on over-indebtedness remain unanswered – in his recent post Rich Rosenberg says “we’re flying blind.” We do not know if over-indebtedness is just a marginal phenomenon in a few crisis countries or if it is a fundamental challenge to the industry. And we hardly know how to find out: Before we can measure over-indebtedness and address it we will first need a fair idea of how over-indebtedness in microfinance is defined.
We can learn a lot from commercial banking and the academic disciplines that have researched over-indebtedness in developed markets:
* Most of us will agree with economists that someone who is no longer able to repay his loans is over-indebted. But then default is the final stage of over-indebtedness and we would like to recognize it much earlier. As soon as we start following the economists on thresholds such as a high debt-to-income ratio, we realize that these are very imprecise and the thresholds rather arbitrary. How should we be able to tell for each country, for each individual, how much debt is too much?
* From a legal perspective, a challenge with default is that only honest borrowers should be eligible for debt relief. We cannot include deliberate default into our over-indebtedness definition but expect each borrower to make the maximum acceptable effort to repay his debt. While most developed countries have defined a minimum existence level that provides a threshold for the maximum acceptable effort, most developing countries have not. And many microfinance customers are probably living below the minimum existence level already before debt problems kick in.
* From a behavioral perspective, microfinance faces specific challenges of informational asymmetries. In most countries there is little information exchange between MFIs, let alone a central credit bureau. It therefore seems an indicator of over-indebtedness if borrowers accumulate loans from several microlenders at the same time, taking a new loan when unable to pay an old one off. However, researchers like Isabelle Guérin have pointed out that multiple borrowing is a common feature in the informal borrowing systems of the poor. Keeping a range of borrowing options active at all times might even be a means to maintain creditworthiness as a personal safety net. Other reasons for cross-borrowing can be the limited loan sizes of MFIs or inappropriate terms and conditions.
On top, microfinance institutions need to make special efforts that their products do no harm. From a perspective of customer protection, over-indebtedness is therefore much more than an inability to repay: it starts when a borrower has to sacrifice too much to be able to repay on time. Some sacrifices may well be acceptable for the borrower for the purpose of the loan but when they’re not – when a borrower is going hungry and selling his last livestock to avoid default – then (s)he is over-indebted. This definition may or may not be in line with risk management. It may discard the idea that high repayment rates prove the absence of over-indebtedness.
It does not necessarily imply that every loan that leads to unacceptable sacrifices should not have been made! The risk of investments going bad always exists. But a responsible lending industry will have to design products and policies that ensure the share of customers making unacceptable sacrifices is very low.
In conclusion, it comes at no surprise. When we want to learn about customer protection we will have to listen to what clients say. The real definition of over-indebtedness needs to take into account cultural differences, the social implications of debt, individual expectations about future income and so on. Only microborrowers themselves will be able to tell to what extent they are suffering from their debt.
This detailed understanding of the struggles over-indebted borrowers face is also what we need to develop appropriate measures of customer protection. It might turn out that the amounts we are lending are not too high but inappropriate installment schedules are making it too difficult for borrowers to repay, leading to sacrifices and the risk of default. In a second step we can identify indicators – and why not from the list above? – that approximate over-indebtedness well enough for MFIs to track its development in the long run. In the mean time I believe we all have an awful lot to learn about this complex phenomenon of over-indebtedness by listening to those we want to protect from it: the clients of microfinance.
For more information check out Jessica’s full length working paper “Microfinance Over-Indebtedness: Understanding its drivers and challenging the common myths.”
Avery interesting and thought provoking post on Microfinance debt stress . I wish to share a few points
1. Values of Subjective qualitative approach and its complexities
.While searching for definition or indicator for over indebtedness, I consider a qualitative approach with subjective perception and sacrifice concept on the debt stress level would be the best judge at household as it would facilitate for working out appropriate strategies for customer protection. Here, I wish to emphasize that once ‘social impact’ is sustained at customer house hold level through effective protective measures for reduction in debt stress , it would certainly lead to ensure good repayment performance which in turn ultimately leads to institutional viability of MFIs . Having said , I also admit the difficulty in precisely perceiving debt stress position of poor housel holds through this quality approach as this is highly subjective depending on individual’s perception on the ‘burden’ or ‘stress’ or sacrifices experienced as a consequence to the over indebtedness problem. To substantiate further, culturally, expenditure for social & religious ceremonies though unsustainable in household budget leading debt burden, can not be reduced as it is question of social status with more values attached.. In this regard another area of concern is entertainment expenditure particularly in television and cinemas with its negative eventualities in the household budget. These media with lot of commercial programmes fuels the propensity to consume more on household articles ostentatiously in the poverty sector. Despite known health hazards implications,, liquor and smoking a part and parcel of life style of the poor many household, have become the main cause of debt burden since it is an ‘accepted means’ of giving energy and of forgetting the onerousness of work and of affirming one’s virility from the poor men’s perspectives. It is therefore to say what is ‘acceptable means’ to one, it may be ‘unacceptable’ to another. Making subtle distinction as acceptable or unacceptable means appear difficult in subjective analysis on debt stress.
Perhaps I feel that it is the poor customers who are ‘flying blind’ chasing ‘ the forbidden apple’ (micro credit) making other also ‘blindfolded’ while tracking. I , though with some hesitation, draw this inference because the poor in Asia and India in particular, appear willingly to anticipate and accept any kind of ‘sacrifices’ for loan obligations since traditionally ‘living with debt’ irrespective of the degree of debt stress, has become ‘a way of life’ by ‘choice’. .In support of this argument, two observations merit attention
a. Indian saying : “Indian farmer is born in debt, live in debt, die in debt, and bequeaths debt”
b. To quote “On the one hand, the only choice people have is between increasing the opportunities for debt, the impossibility of living without going to debt, and, on the other hand, a “second- rate” life, expenditures reduced to the minimum at the cost of malnutrition and degradation of social status. The temptation to repay a debt by means of new loan is too strong; it become a way of life”(Marc Roesh, Cyril Fouillet, Isabella Guerin- ‘Debt, Debt burden and interest rate; Has the microfinance machine ‘gone made? Crisis in AP(India)’ .
As it appears from the above that the real life situation at individual household level in the given socio economic cultural profile of poverty sector , reveals involuntariness in over indebting themselves with unabated sacrifices and makes the things complicated while applying any rationality or morality in the perception of one’s sacrifices or ‘unacceptable means’. Sometime decapitalization in the form of selling the livestock, or gold ornaments (common feature among the poor) for clearing the over indebtedness is considered acceptable sacrifice. In this context, the question ‘ how much is too much ‘or when is too much ?’ remains begging demanding a robust multidisciplinary study on the above phenomenology in Microfinance arena.
2. Feasibility of Objective quantitative approach
Regarding objective quantitative approach, the indicator for over indebtedness is mainly based on economic means (debt-to – income ration) representing excess of certain quantitative threshold . By and large the banking system in the formal sector only strictly adopts this approach for monitoring the performance of assets under priority sector lending at institutional level and overdue level at customer level as well.
In this approach debt associated variables like ‘ the interest rate, and ‘the date scheduled for repayment’ as per contract assume vital in deciding the status of over indebtedness .Based on ‘economics’ of each credit product/scheme and the social profile of the poor , along with the size of the loan, interest rate , the repayment schedule is prepared.. It may be noted here that debt stress and sacrifices as well are very less to the poor borrowers during the repayment holiday period .For example, in the case of crop loan the repayment date is fixed only at the time of harvest of the particular crop for which loan is given depending on the cultivation period. For the same crop loan , the due date for repayment or repayment holiday will be different for short duration crop ( say 3 months holiday for food crop ) and longer duration crop ( 1 year holiday for commercial crop like sugar cane). Similarly in the case of animal husbandry based loan , for dairy animal there is some repayment holiday during non lactation period, one year holiday for goat/sheep rearing, 6 months in the case of poultry,3 months every year during monsoon seasons in the case of fisheries (It is therefore important to note the influence of the variable factor viz., repayment schedule and interest levied while probing over indebtedness . In the case of faulty application of repayment schedule or uniform application of the schedule without appropriate repayment holiday, it would likely subsume wrongly many borrowers in the over indebted category . This situation ( weekly/monthly immediately after the loan disbursement) is precisely prevailing in MFIs forcing the customers high level of sacrifices . In the case of debt from money lender /pawn brokers/friends/relatives , the repayment of principal loan is flexible while interest due is to be paid periodically .This kind of informal system provides a cushion to save some ‘ unacceptable sacrifices’ to the poor at least for a short period.. This different approaches for repayment schedule prevailing among different sectoral lending institutions, point out that every loan does not lead unacceptable sacrifices at customer level and different style of risk management of their asset portfolio at institutional level..
I have elaborately covered in my last response to Rich on the various factors responsible for over indebtedness both from institutional and customer fronts besides covering external factors.
3.Suggested measures for customer protection
1. Establishment of customer protection at lower level exclusively for MF clients with the focus on credit discipline and credit planning
2. The loan norms and procedures based on economic means as followed in Banking system need to be followed. As per the recommendation of The Malegam committee ,recently constituted by Reserve Bank of India at least 75% of loans extended by MFIs should be for income generation purposes . Since this type of loan is treated as priority sector status, MFI s also should strictly follow the norms and procedures including appropriate repayment schedule and minimum period of moratorium, based on economic principles as followed in banking system. For avoiding multiple lending and over borrowing borrower can be a member of only one SHG or JLG
3. Credit planning at SHG /MFI level based on potential and supporting facilities in the given service area . This micro credit plan should be integrated with overall district/regional development plan so that arrangement of physical infrastructure for supporting micro credit functioning at file level is ensured by local government
4. All the income generating assets need to be protected by micro insurance besides the life of the customer. Similarly the livestock purchased out of micro loan should be covered under livestock insurance. The claims need to be utilized for rejuvenation of income generating livelihood and not for adjustment of loan dues. These insurance services may provided singly or jointly .
5. Consumer loan should fall outside the purview of Micro finance. MFIs need to diversify their MF services besides micro credit foraying into micro insurance services for financial sustainability and social impact as well simultaneously.
6. Avoidance of coercive method of recovery and as far as possible the repayment for production loan is to be tied up with marketing of the product
7. Financial literacy, credit counseling and capacity building for customer and Promoting thrift and savings through SHG/FEDEARTION