Over-Indebtedness and the Role of Investors
The consequences of over-indebtedness are shared among all stakeholders in microfinance. Households, individuals, and communities are affected by borrowers who cannot repay their debts. They risk the loss of livelihoods, reputations and the chance to improve their families’ lives. MFIs that lend to over-indebted borrowers face potentially large loan write offs.
Microfinance Investment Vehicles (MIVs) that lend to these MFIs also face losses, directly affecting both the financial and social return to their investors.
Similarly, all stakeholders in microfinance share responsibility for building healthy credit markets and confronting, controlling and preventing over-indebtedness. MFIs must develop rigorous credit methodologies and train and properly motivate loan officers. Regulators, politicians and the broader financial sectors in these countries must play engaged, supportive roles – but not become overly zealous.
And international investors and lenders also have a unique accountability when it comes to how markets grow, particularly since leading up to the crisis, when markets like Bosnia and Nicaragua were considered highly successful; MIV managers were the largest sources of credit.
The significant flow of capital from MIVs is not news for participants in these markets. In fact it has recently been the thesis of various industry reports and publications. BlueOrchard is an active supporter of thorough examination of the circumstances and negative consequences of over indebtedness. As the British composer John Powell said, “the only real mistake is the one from which we learn nothing.”
BlueOrchard’s response to over-indebtedness has taken several forms, as investors typically seek both a social and financial return. In the last two years the firm continued investing during the crisis, and the portfolio across all debt funds that BlueOrchard manages grew by 12%. During that time the loans made in the top 10 largest country exposures dropped by 11%. Those markets are receiving less funding from BlueOrchard even though the capital available to finance them grew. As a result, they went from representing 75% of the portfolio to just over 60%.
BlueOrchard also greatly enhanced its social performance activities in recent years. A social performance assessment tool was developed and the scope of due diligence visits and credit memos was expanded, covering areas like over-indebtedness in particular. Diversification, concentration limits, enhanced risk management and outreach to new markets (e.g. Africa) are some of the other tools used to help manage involvement in more competitive markets while ensuring the achievement of social mission objectives.
Likewise, much as investors encourage information-sharing among MFIs (as several Bosnian MFIs did in 2009 before reporting to the Credit Bureau was mandatory), collaboration with other MIVs has become much more common– and far more so than in the mainstream investment community. Some interesting examples of recent teamwork on the issue include:
- Industry-wide campaigns like the Principles for Investors in Inclusive Finance (PIIF) and Smart Campaign, which incorporate principles on responsible approaches to competitive markets and risks of over-indebtedness, and have been endorsed by almost all international investors of significant size.
- The Microfinance Lenders Working Group (IMFLWG) convened by IAMFI and comprised of 10+ investors working together to better understand the challenges associated with MFI debt defaults and restructurings, and proactively develop best practices and tools to facilitate orderly workouts.
- A joint effort of 12 microfinance investment firms to look more closely at a market recently identified as “relatively high risk” according to the Early Warning Index: Peru. The openness between competitors has been impressive, sharing initiatives being undertaken at the respective organizations, and agreeing to work together to obtain information, particularly at the client level.
The increasing development and maturity of the microfinance industry has sadly led to some institutions pursuing aggressive lending practices in order to continue growing. In this context, MFI management teams, regulators, loan officers, credit bureaus and investors too must take decisive and substantial moves to fight over-indebtedness. Responsibility for building a healthy credit market lies with all stakeholders.
Since over indebtedness problems pertains to micro credit service (among other MF services) there is an imperative need for building healthy credit market. This therefore calls for a strategic planning and ,management of micro credit at MFI/SHG level .This is an important the fact ignored or neglected in the past causing over indebtedness in MF arena.. For a building healthy credit market following points emphasizing the need for integration of given physical support and other non financial support for enhancing the productivity of micro credit contextually may be useful for HRD particularly for loan officers. Among the stake holders, government has also responsibility to arrange for creating adequate physical support for credit related activities at the grass root level.
1. Analysis on credit absorption capacity of the given area/region
2. Formulation of potential linked Micro credit plan for the MFI/SHG
3. Integration of micro credit products with micro insurance and micro savings
4. Integrating repayment mode with the agencies of marketing of the proceeds
5. Integration of income generation period with the repayment schedule
A healthy credit market with a well trained loan officers on the above lines indicated is to be developed as it would ensure expected financial and social returns on one hand and reduction of debt stress problems for both the lender and borrowers on the other..
The consequences of over-indebtedness are not necessarily shared among all stakeholders in microfinance. In Andhra Pradesh, the crisis of over-indebtedness remained unobserved because there was no repayment crisis.The collection machinery worked efficiently. How did the clients meet their repayment obligations? This did not matter to MFI’s.
It was a silent crisis among many microfinace clients which erupted suddenly in the third quarter of 2010. There were reports of suicides by a numer of microfinace clients followed by load protests and political interference. The repayment levels plumbed to new depths.
The MFI’s were not concerned with the problem of over-indebtedness, they are concerned because of the crisis of default in repayments.