MICROCAPITAL STORY: Over-Indebtedness And Borrower Delinquency In The Indian State Of Karnataka

In a recent entry posted by Mr. Siddharta Chowdri, ACCION International Country Manager for India, on David Roodman’s Microfinance Open Book Blog, it was pointed out that borrower delinquency has become a problem faced by all MFIs in the Indian state of Karnataka. According to the Mr. Chowdri, microfinance clients in the state are borrowing from as many as 6 MFIs and many local money lenders. Many existing MFI’s in the area do not have the systems to track and monitor how much debt their clients are incurring as a result of loans from other MFIs. A good number of clients borrow excessively and exceed their capacity to repay their multiple loans on a timely basis. As a consequence, some of these clients turn to local leaders with complaints about MFIs and their inability to repay their debts. To add to the problem, a number of local leaders have instructed certain MFIs to cease operations and have informed borrowers via the local media and through word of mouth that they are being exploited. There is some suggestion that the actions of some local leaders in this regard may be politically motivated.

The blog notes that such actions have led to increased financial exclusion as certain MFIs in the area have shut down or reduced their operations. There are concerns that the reduction in the disbursement of loans by MFIs will have adverse consequences for borrowers in the Karnataka area. Mr. Chowdri notes that this is an alarming development for the microfinance industry and suggests that the root causes of borrower delinquency – namely the lack of systems to track client indebtedness, unfettered competition in the MFI sector, irrational growth expectations and insufficient analysis or understanding of a borrower’s repayment ability – must be addressed as a matter of urgency.

According to comments to Mr. Chowdri’s blog posting by Mr. Bhalchander Vishnwanath of United Prosperity, an Indian non-profit grassroots organization which focuses on poverty alleviation, the introduction of systems and credit bureaus to track borrower indebtedness and the promotion of information sharing between MFIs are important measures. However, these measures alone are unlikely to resolve the problem of over-indebtedness in the long run. MFIs that have secured financing from equity investors who expect high minimum returns are likely to feel subject to increasing pressure to lend even to borrowers with existing debt. Mr. Vishnwanath notes that it is difficult for MFIs to main strict internal controls in an environment where there are strong incentives to reach business targets and achieve certain profit margins. The risk here is that when over-indebted borrowers default, the MFI potentially faces significant losses and possible bankruptcy particularly where such micro-loans are unsecured.

It is not uncommon for microfinance clients to borrow from more than one MFI. A recent entry by Mr. Christoph Kneiding, a Market Intelligence Officer for CGAP, on the CGAP Microfinance Blog entitled ‘Is More Credit Always Good Credit’ considers the problem and causes of over-indebtedness. Casual empirical evidence suggests that clients who borrow from more than one MFI are more likely to default on their loans. Researchers from BRAC, one of Bangladesh’s largest MFIs, have produced graphs which show that repayment levels drop from 90 percent (in households who only borrow from BRAC) to 50 percent (for households that borrow from BRAC and other MFIs). It is unclear if the poorer repayment profiles are due to increased competition among MFIs that leads to poor repayment discipline or simply the result of over-indebtedness caused by borrowing from multiple institutions. BRAC’s results in this context are in no sense representative of the entire microfinance industry. As noted on an entry on MicroLinks, a USAID portal on learning and knowledge sharing on microenterprise, many poor and low-income people have multiple loans simply as a cash flow strategy, but they are able to handle the loans well and repay on time. Nonetheless, BRAC’s results do raise some important questions.

A detailed comment to the ‘Is More Credit Always Good Credit’ blog entry by a blogger identified only as Mr. V Rengarajan is noteworthy. He observed that over-indebtedness must be assessed from both the supply-side and the demand-side. In relation to supply issues, over-indebtedness can stem from several factors including a poorly regulated environment, compulsion to reach business targets, unhealthy competition between MFIs, insufficient scrutiny over borrowers’ credit discipline, the disbursement of repeat loans on maturity of the first loan, a lack of demand-oriented microfinance products and services, a lack of a connection between income generation and the loan repayment schedule and an absence of micro-insurance coverage. In addition, the willingness to waive or forgive indebtedness by policy makers in response to political pressures may do more harm than good as it fosters poor financial discipline.

On the demand-side, Mr. V Rengarajan observed that over-indebtedness can arise where borrowers have a poor capacity to pay, misuse their loan, use their loans for consumptive purposes (such as to pay for health services and other material goods) without entering into adequate income generation activities and lack the support or advice necessary to understand the causes and implications of over-indebtedness.

Over-indebtedness is a problem that is in all likelihood not unique to the state of Karnataka. A solution to the problem may not lie in the simple introduction of credit bureaus and better systems but in a detailed analysis of how the multiple factors referred to above interact in any particular environment. Bearing in mind that blog entries may be anecdotal or lack independent supporting evidence, the comments referred to above nonetheless raise some pressing issues. The Microfinance Gateway portal, a CGAP-sponsored online database which contains publications on microfinance-related topics by various sources, includes articles on over-indebtedness and borrower delinquency in the microfinance world. Links to some of these articles are set out in the ‘Additional Resources’ section below.

Additional Resources:

Microfinance Gateway portal: Debt Literacy, Financial Experiences And Over-Indebtedness

Microfinance Gateway portal: How Can MFIs Best Work In Competitive And Saturated Markets

Microfinance Gateway portal: Private Initiative In Regulating Financial Discipline

Microfinance Gateway portal: Competition And Multiple Borrowing In The Indian Microfinance Sector

Microlinks: Over-indebtedness in the Region — a Crisis in the Making

Institute of Research for Development (University of Provence): Microfinance, Indebtedness and Over-Indebtedness