Is Microcredit Over-Indebtedness a Worldwide Problem?

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.