Over-Indebtedness and Impact
What a pleasure to see this discussion evolve – I believe that a broad discussion is what this over-indebtedness question needs. By involving everyone’s needs and concerns we will first of all learn that it is not “one” solution we are looking for. It is instead a set of responses to the various needs to understand over-indebtedness, track it with easily measurable indicators, or to determine its boundaries for legal purposes.
A sacrifice-based definition will be useless for the latter two due do its subjectivity, its cultural dependence, it’s vulnerability to dishonesty, and the amount of work required to measure it. If my interest for the time being focuses on the first, that is because I believe that a sound understanding of the concept in its abstract, hardly measurable form, is what will guide us to choose the right indicators for other purposes. The same will be true for the different perspectives of protecting customers, managing MFI portfolio risk, and improving business through customer satisfaction.
So with regards to this conceptual definition, holding up the priority of protecting clients from harm, Rich has raised an important challenge: how do we know if sacrifices without loans wouldn’t have been even worse? I hope to be able to soon share results from our empirical work in Ghana, in cooperation with the Smart Campaign and KfW: With all the downsides of subjective information, the borrowers seem again to be the best judges if difficulties are or are not related to their loans. And changes in sacrifices over time may be another indicator.
As tempting as it is, the tendency to mix the over-indebtedness question with the impact question may also be risky. Is it a loan that makes the borrower worse off that makes him over-indebted? No legal definition would ask if the loan was the origin of the borrower’s troubles. If borrowing does not cause the sacrifices but makes people more vulnerable to the shocks that they have always experienced – isn’t that important when we argue for microfinance as a form of vulnerability reduction? If it is just the lending terms (e.g. the lack of a grace period as argued in V.Rengarajan’s comment), not the amount of debt that makes the borrower struggle, is that not the type of debt problems we want to protect borrowers from?
We should not expect the over-indebtedness definition to solve the impact debate just in passing by. And testing the causal relationships in an econometrically valid way, observing how many sacrifices we can cause for people with different treatments has some serious ethical challenges. But what if each impact study, each Randomized Control Trial that was done in the future asked about the sacrifices people made before and after taking loans? How about if we included this potential downside in our standard approaches to thinking about impact? It will certainly enhance our understanding of what microfinance does and does not do for poor people and how its products and services can be improved. I am looking forward to others taking over and turning this blog series more towards the operational questions of tackling over-indebtedness and developing solutions. There are a million ways to go about it. By creating the transparency and the literacy for empowered consumers to make informed choices, we are likely to go a long way.
Also in this Series
Over-Indebtedness in Microfinance – Who Should Bear the Risk?
While microfinance products and lending methodologies vary significantly on the ground, two main features of microfinance have made this enormous expansion of access to finance possible: microlending has become scalable due to cost efficient operating models and due to risk management methodologies that ensured high repayment rates.
We Need to Keep Learning about Overindebtedness
We need to look more carefully at the interactions between microfinance institutions and their clients, examining how MFI practices play out in lives of clients on an everyday basis. Stuart posed two specific hypotheses: if a lender needs clients to borrow continually, it incentivizes overselling and overindebtedness, and that insistence on immediate, in-full repayment drives some clients to begin bicycling loans.
Comments
Dear Jessica
Dear Jessica
It is good that the most vital factor –‘ lending norms’ has been well brought to surface among others drawing the attention of the researchers in the discussion on over indebtedness from customer perspectives. The subjective value of ‘grace period’ for micro credit lending in particular is reflected in terms of reduction in ‘sacrifices’ or increase in ‘saved sacrifices’ at poor client household level (though short period) and adherence of ethical codes in economic means at lenders level. Whatever admitted complexities for adoption of the subjective conceptual framework for defining over indebtedness from customer perspectives, the above discussion , I feel, has provided a strong base for considering exclusion of ‘consumer loan’ from the preview of micro finance
Having discussed conceptually, some operational questions of tackling over indebtedness with reference to micro insurance services among other tools.
1. What is the role of micro insurance in addressing the vulnerability of poor client? Has it facilitated in reducing the severity of both expected and unexpected sacrifices at client household level? In what terms? Has it favored more to female borrowers ( who reportedly make lot of sacrifices ) for saving their sacrifices ?
2. Is it rational to establish causal relationship between insurance based protection and basic survival capacity for making smooth repayment at client level?
3. Will there be any difference in the impact on the level of indebtedness and the level of sacrifices between two groups of micro borrowers households- one covered with micro insurance and another one without micro insurance coverage in the given service area of MFI ?
4. To what extent does the integration of micro insurance with micro credit products facilitate protection to the clients in terms of saved sacrifices subjectively and revival of livelihood economically with unchoked income generation and repayment impacting less debt stress to the customer. ?
5. In the context of well protected income generation process or productivity of micro loan by micro insurance services at client level , does the smooth repayment ensure good recovery and risk free asset portfolio management at lending institutional level?
6. How does the micro insurance coverage for micro credit products intended for various livelihood (agriculture and animal husbandry ) facilitate the poor client coping with or mitigating the impact of covariant risk (drought ,flood, storm etc) in terms of less debt stress and rejuvenation of livelihood without much sacrifices ?
7. Will diversification of MF products ( micro credit with micro insurance ) help MFI ensure social impact at client level and financial stability at institutional level as well for avoiding mission drift ?
8. How far the coordinated Endeavour among the public and private insurers either with or through MFIs ensure insurance coverage to all the micro credit borrowers and thereby reduction in debt stress problem. to the micro borrowers community?.
In fine, I have been reiterating invariably the values of micro insurance for poor customer’s protection in all my responses to various postings in this MF blog including the one to Rich recently. But what I wonder that albeit inclusion of ‘micro insurance’ service also in microfinance conceptual framework, why the values of micro insurance have not received deserving attention of MF practitioners at large and researchers in MF arena in particular in their quest for developing solution to issues related to microfinance including ‘ over indebtedness problem’. ( a by product of micro credit services another component of MF services ) ?
I am keen to look forward to see the findings on the insurance factor in your Ghana research
Thanks & Regards
Rengarajan
Thank you Jessica for your
Thank you Jessica for your interesting insight. I would like to add a few comments regarding the common concern of avoiding over-indebtedness, which, if I understand correctly, you define as a ‘pre-stage’ to default.
The findings by Isabelle Guerin surprise me, I do not see how the ability to cycle off loans is in fact a means to maintain credit-worthiness. What does she define as credit-worthiness, or more importantly how does she calculate it given the high levels of a-symmetric information? Starting from a purely behavioral-economic perspective; too much ‘sudden’ access to financial resources automatically results in unreasonable spending. That should be no surprise and we do not need to look far to observe it. In addition the multi-credit theory makes it ridiculously difficult for MFI’s to judge the progress of their borrowers given that they have the possibility of repaying interest rates using other loans. As a result it is impossible to recognize difficulties at a pre-mature stage, such that by the time interest-rates run dry- it is often too late. A-symmetric information in microfinance is a huge negative externality, which must be overcome by one-to-one interaction and trust. If an individual acquires loans from different avenues, they are torn between different rules and regulations, advices and support.
Microfinance has evolved and is no longer purely the idea of providing financial services to the poor to set up a sustainable business. As a result of this ‘deviation’ from its initial ‘platform’, microfinance has evolved to become highly vulnerable to economic shocks in the global economy. The risk of over-indebtedness starts right there: the loan depends not upon the microenterprise but upon their family members salaries which they earn in factories, shops, around the country.
So how do we know if sacrifices without loans wouldn’t have been even worse? Of course, in many cases we do not know but should not think about the counter-factual all too often. Even then, we once again root back to the issue of the type of loan that was provided. If it was a pure consumer loan to buy a TV, solar panel lamp etc. then I could quite firmly say that the sacrifice is restricted to not having a lamp/TV for X number of years (and their related benefits). Thus in aggregate, the sacrifice without the loan could not be worse
Best,
Mary
Dear Mary,
Dear Mary,
Many thanks for your comments!
While I agree that multiple borrowing can make lending decisions much more difficult for MFIs, let me briefly explain how multiple borrowing may in some cases be related to maintaining creditworthiness:
Particularly in the informal financial sector, moneylenders and other potential sources of potential support with credit tend to lend more readily to borrowers whom they know rather well. A positive credit history, that is the repeated experience that a borrower has repaid well, enhances creditworthiness for future situations. It may therefore be useful to keep ongoing credit relationships with several potential lenders active so as to have access to them in times of need.
The same may be true for MFI borrowing where borrowers sometimes start accepting small loans that are rather useless to them in the hopes of building a credit history with the institutions and qualifying for larger loan sizes. Others will continue to take out loans with their group in every new loan cycle, independently of their current credit requirements. They may simply want to stay part of the group and maintain their access to credit.
Nevertheless, the creditworthiness comment was rather a side remark and is neither universally true nor a genral waiver of concerns about multiple borrowing!
Best
Jessica
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