Understanding Multiple Borrowing and Avoiding Over-indebtedness Among Clients

February 2, 2012    

On January 12 and 13, CGAP, IFMR, and MicroSave hosted a virtual conference to discuss thoughts and experiences around multiple borrowing and avoiding over-indebtedness. Over 200 microfinance institution managers, investors, advisers, and researchers from 48 countries shared their ideas, generating over 700 comments and numerous suggestions for MFIs, policymakers, and funders in what turned out to be a fruitful and invaluable exchange.

Conference participants agreed that multiple borrowing is not a problem per se. Some studies show the positive benefits of multiple borrowing on clients as they use it as a type of risk mitigation strategy. There was also consensus that multiple borrowing is not synonymous with over-indebtedness; nor does it necessarily lead to over-indebtedness. Many clients manage loans from multiple lenders without significant problems, while others can get into debt troubles with a single MFI loan.

Multiple borrowing is often a sign that products offered by an MFI are not designed quite right for its clients, forcing them to seek additional loans elsewhere to meet their needs. One key strategy for reducing multiple lending (or keeping it from becoming a problem) is for MFIs to analyze clients’ behaviors, cash flows, and needs and redesign their products and processes accordingly.

There currently is no strong evidence regarding the prevalence of over-indebtedness; however, it is a serious issue that warrants better understanding. Participants discussed at length the contributing factors of over-indebtedness including:

• Lack of education and awareness among clients
• Information asymmetry between clients and providers
• Inadequate operations and processes among retail providers such as inflexible products and services, supply-centric operations, inadequate loan appraisal processes and staff incentives
• Commercialization and competition shifting the focus on short term and rapid growth

Participants also discussed the need for reliable early warning indicators to help identify over-indebtedness before it gets out of control. Existing indicators have limitations. Demand-side indicators are the most thorough but are the most expensive to track; supply side indicators are cheaper to track but less reliable. More work is needed to develop better methods and tools.

A number of concrete suggestions for how MFIs can work to prevent over-indebtedness emerged in the conference. These suggestions include:

• Shift the focus back to clients and build long-term relationships with them; interactions with clients should achieve the objective of understanding their financial needs.
• Move away from a credit-only focus and incorporate other important products such as savings.
• Reconsider motivations for expansion, check market saturation levels, and consider moving into untapped markets.
• Institutionalize client protection principles and embed in operations through operations manual and training, and code of conduct.
• Train MFI staff to appropriately estimate loan absorption capacity of clients and identify instances of multiple borrowing and over-indebtedness; train staff to carefully assess household cash flows.
• Use more rigorous loan application processes to include cash flow analysis, income projections, early client visits and deep analysis of client’s capacity and willingness to pay.
• Improve internal controls to monitor loans event after loan disbursement; strengthen internal audit function with follow through and penalties.
• Align staff incentives with the goals of responsible lending: portfolio quality, client retention and customer satisfaction are important measures to include.

Funders are also part of the solution as they have a large responsibility in setting the agenda, keeping in mind long-term goals over short-term growth and profits, and communicating these goals effectively to their partners. Ideas for funders include:

• Define clear social and financial criteria for investing, assess performance against these criteria periodically and take action. More specifically, set multiple lending standards and enforce them.
• Strengthen due diligence of MFIs by addressing credit policies, methodologies, staff training, incentives and controls.
• Support MFIs in their efforts to improve client protection, social performance, and impact. Share experiences and best practices.
• Participate actively in industry-wide initiatives including sponsoring or conducting research on client protection and over-indebtedness.
• Work with regulators to develop credit bureaus and encourage/require MFIs’ participation.
• Improve coordination at country-level, including pooling resources

Participants saw also a clear role for policy makers in combating over-indebtedness, and suggestions included:

• Establish and enforce client protection policies, more specifically disclosure guidelines for product terms and pricing as well as redress mechanisms. At the same time, ensure that compliance is not too burdensome and expensive for providers.
• Support development and regulation of credit bureaus and require MFI participation.
• Regulate competition or regulate the conduct of MFIs with incentive structures.
• Promote financial literacy training so individuals can make informed decisions about the products and services they use.

For an archive of all 21 sessions of the virtual conference, please visit virtualconference.cgap.org.

Additional information is also available on the following websites:

• CGAP's Blog Series on Over-Indebtedness
• The Microfinance Gateway, Calling All Stakeholders: How to Prevent Over-Indebtedness
• IFMR’s India Development Blog, Virtual Conference on Multiple Borrowing and Over-Indebtedness
• MicroSave's blog post, Making Clients' Lives Better, Not Bitter