A Way Out of High Growth and Multiple Lending Indebtedness Trap

The global debate on over-indebtedness tends to focus on the role of high rates of growth as its cause. The argument is that growth is sustained by the less responsible MFIs who target easy to reach clients – the low hanging fruit – encouraging them to borrow and inadvertently getting them into trouble as a result. This defines over-indebtedness as a supply-driven problem.

While this phenomenon undoubtedly plays a significant part in creating over-indebtedness, it would be useful also to look at the problem from the product design and demand perspective. Is there something about the product design that inherently fails to fulfill demand and leads to microfinance clients actually chasing after loans, sometimes too successfully, thereby getting themselves into trouble?

Whatever our concerns about over-ambitious, even greedy, promoters no one actually forces people to take loans beyond their repayment capacity so there must also be something in the conditions under which the industry operates that leads to clients choosing to take more and more loans.

One of the results of the exponential growth of the microfinance industry in many countries in Asia is that MFIs have had to hire ever-larger numbers of staff and train them in ever-shorter time periods to enroll clients and disburse funds.

As a result, there has been limited success in inculcating staff with the microfinance mission of targeting the poor and excluded, and building relationships with them. It is relationship building that enables staff to understand the lives and livelihoods of their clients and, thereby, to support them in meeting their financial needs in a service environment. On the contrary, MFIs have recently limited the loan size to unrealistically low levels (currently just 12.5% of per capita GNI in India and not much more in most of South Asia).

This allows them to minimize risk by limiting the size of the loan installment and reduce costs by virtually eliminating the task of loan appraisal, reducing the qualifications and, with it, the salary of a loan officer. Unfortunately, this lending methodology has driven microfinance in India into a methodological cul-de-sac, with the current microfinance crisis there, and less dramatic crises in other parts of South Asia, as the inevitable result.

It is not surprising that the net result of growth has been pressure on loan officers to cut the effort they put into client acquisition and attempt to acquire clients from other MFIs. The client, unsatisfied with the amount of financing available, inevitably seeks loans from multiple MFIs to meet her needs. This has caused an environment of micro-money circulation that resembles a hot house in which women from low income households must shuttle to 2-5 MFI meetings per week while managing households, families and contributing to micro-enterprises at the same time. Unfortunately, in obtaining “easy money” from multiple agencies, a few clients mismanage their financial affairs, as people tend to do at any level of society, and cases of over-indebtedness emerge.

The answer to this problem is encouraging MFIs to move beyond lending a pittance to the poor and move into real microenterprise financing. This would entail a number of changes: first, undertaking thorough loan appraisals to determine the real financing needs of the client; second, providing much larger loans than they do at present (perhaps between 50-100% of GNI in South Asia); third, as a consequence, hiring better educated staff at higher salaries and training them to perform good loan appraisals, and build relationships with clients.

The higher cost of this activity would be met by a larger outstanding loan size and the resulting slowdown in disbursements would also be beneficial in ensuring a more measured growth rate. This solution implies a radical change in the microfinance business model (at least in Asia) but in the given circumstances it would be good for microfinance and good for financial inclusion.