CGAP has just published a study that Jessica Schicks and I have written on over-indebtedness among microborrowers. The paper is not exactly bedtime reading: I’m slightly embarrassed to say that it runs to 43 pages. So some readers may feel like the third grade student whose book review began, “This book told me more about whales than I wanted to know.”
It’s been an interesting exercise to go back over the paper’s detailed discussion and cull out a few conclusions that feel important enough to highlight in a blog. The first big message has to do with the question in this blog’s title. After many years of enviable repayment performance, serious default problems have broken out in recent years in Morocco, Nicaragua, Bosnia/Herzogovina, Pakistan, and Andhra Pradesh in India. Some of this default is probably “strategic”—borrowers who could easily repay take advantage of political or other situations to stop making payments. But much of the default appears to be due to over-indebtedness. (Without going into the complications of defining “over-indebtedness,” let’s just say for now that it refers to borrowers who can’t repay their loans without serious difficulty. Note that this is a client-centered definition, and that it implies that borrowers can still be over-indebted even if they manage to pay off their loans.)
Are these five markets the tip of a worldwide iceberg? Is over-indebtedness a big problem in a lot of other countries? The answer is an unsatisfactory one: no one knows. Jessica and I found only six studies that tried to quantify microcredit over-indebtedness in individual countries, or parts of countries. Jessica is about to publish a seventh. Generally, these studies have found worrisome levels of over-indebtedness, but we can’t generalize from this small sample, because it is highly skewed. Most of the studies were implemented in locations where there were pre-existing signs of problematic debt levels. So Jessica and I don’t know how widespread debt problems are, but we argue that there a strong reasons to treat over-indebtedness as a clear and present danger in quite a few markets.
Which markets? That brings me to the next big point the paper makes. In an increasing number of markets around the world, microcredit has been so successful that the supply of it is catching up with the demand for it. In other words, markets are approaching saturation.
Let’s pause for a moment here, because for many people talk of market saturation seems odd when most of the low-income population still doesn’t have a microloan. This is because there has been a tendency to overestimate the actual demand for microcredit, sometime drastically (as Malika Anand and I argued in a 2008 CGAP Brief ). The reality is that at any given time, many low income people simply do not want a microloan, while others may want a loan but would be likely to have payment problems if they were given one. Still others can’t be served viably with presently available methods. So supply catches up with effective demand sooner than we might think. This was clearly happening in Morocco and Bosnia/Herzogovina, for instance.
Microcredit has some unique features, but it is one of many different forms of retail (that is, household-level) credit. What happens when retail credit markets approaches saturation? As Gabriel Davel (former chief credit regulator in South Africa) argues, when a competitive retail credit market gets saturated, over-indebtedness problems are practically inevitable; they are not just the result of a couple of rogue lenders’ irresponsibility. Foresight and preparation can reduce the severity of the problems, but problems there will be. This blog is already long enough, so I will refer readers to the paper if they want an explanation of why this happens.
In a nutshell, one microcredit market after another is entering into a new, uncharted world of credit saturation. In these markets, over-indebtedness will probably pose a major risk for clients, not to mention the lenders. As I said, a clear and present danger. Yet in most places we are flying blind right now. This is unacceptable, at least if client welfare is still our core goal. In a later post I’ll talk about the paper’s biggest policy recommendation: that we need to focus urgently on developing early warning systems, so that we are not caught unawares the way lenders and regulators were in the five problem markets I mentioned at the beginning of this blog.
Over-indebtedness is a bad thing and it must be avoided to protect the clients. Nevertheless, considering over-indebtedness as the culprit responsible for growing defaults and failure of some famous MFIs in Pakistan, India and elsewhere, is incorrect. The argument against over-indebtedness is based on the perception that poor can’t make right choices for themselves. Some of the poor may be tempted to borrow beyond their repayment capacity if they are provided with unsupervised access to loans and little guidance. Generally, I think, poor are likely to make correct choices if they are provided with right guidance and a little supervised access to microfinance.
Analysts, who were analyzing the reasons of growing defaults and failure of some MFIs in different countries, were influenced by some initial studies and comments of practitioners, who in lieu of exposing their own faults prefer to hold something outside their immediate control as responsible for their failures and massive defaults. To find the real culprit, a deeper analysis of MFIs’ operations and what mistakes they often make, while growing, needs to be done.
Masood Gill, Pakistan
Thank you Richard and Jessica for this interesting paper, I look forward to reading it!
I just wanted to refer you to a brief insight of the paper you mention on this blog Jessica is about to publish for her PhD at the Center for European Research in Microfinance (CERMi). Together with the Smart Campaign at the Center for Financial Inclusion at ACCION International and with the Independent FC Evaluation Unit of KfW Entwicklungsbank, the German development bank. 531 microborrowers in urban Ghana were interviewed to find out when and how clients perceive over-indebtedness.
You can read more about it here: http://centerforfinancialinclusionblog.wordpress.com/2011/11/03/repayin…
I agree with Masood Gill that the lenders carry most of the responsibility for over-indebtedness crises. But I think it’s also clear that some non-insignificant portion of borrowers make bad decisions, just as many better-off borrowers do. In the paper, we refer to work of behavioral economists who explain why we should expect substantial amounts of non-optimal borrower behavior. I believe that recognition of borrower biases can help lenders and regulators do a better job of limiting over-indebtedness.