MICROFINANCE PAPER WRAP-UP: “Too Much Microcredit? A Survey of the Evidence on Over-Indebtedness;” by Jessica Schicks, Richard Rosenberg; Published by CGAP (Consultative Group to Assist the Poor)

By Jessica Schicks and Richard Rosenberg, published by CGAP (Consultative Group to Assist the Poor), September 2011, 44 pages, available at: http://www.cgap.org/p/site/c/template.rc/1.9.55377/

The authors of this paper discuss over-indebtedness from the perspective of microborrowers and examine related issues including evidence of its prevalence, causes and consequences. Over-indebtedness, as the authors define it, occurs when borrowers have serious problems repaying their loans. While the authors assert that the objective should be to reduce the prevalence of over-indebtedness, they acknowledge that complete elimination is not a practical goal, as there is often a trade-off between over-indebtedness on one hand and access or cost for borrowers on the other. The only way to eliminate over-indebtedness completely is to stop lending.

The authors make a case for intensifying the research and resources devoted to reducing over-indebtedness, noting that evidence suggests that it is more prevalent and that its consequences may be more serious than previously believed. India and Morocco are among the countries cited as becoming more competitive and saturated, thus more exposed to the risks of over-indebtedness. Behavioural economics suggests that “borrowers don’t always make smart choices” and raises doubts regarding relying on microborrowers’ prudence to keep their borrowing levels healthy. Additionally, strong repayment statistics do not necessarily mean that there is no problem, as even a borrower who repays a loan faithfully may encounter very serious problems in making the payments. Aside from its negative impact on borrowers, over-indebtedness can also lead to political backlash and regulatory overreaction. Furthermore, the authors note that there is less confidence recently in the belief that microcredit can “raise millions of people out of poverty” and that the actual benefits are more modest. The possibility that benefits of microcredit may be less than previously believed requires a much lower tolerance for the downside, such as over-indebtedness.

The authors find that lender practices, borrowers’ behaviour and external factors can all contribute to the problem. For instance, over-indebtedness may ensue from a lack of transparency in advertising loan conditions, which reduces a borrower’s ability to make an informed decision. A heavy focus on growth may also push a microfinance institution (MFI) to relax lending standards. Lenders that engage in aggressive collection methods sometimes add to borrowers’ struggles. Borrowers, on the other hand, may put too much weight towards immediate gratification and pay little attention to future consequences, such as loan repayments. In other cases, external factors such as a job loss, an accident, natural disaster or changes in government policies may also contribute to over-indebtedness.

The authors examine various definitions and measurable proxies of over-indebtedness and determine that all suffer from limitations. For survey work, the authors recommend an indicator that is based on the struggles and sacrifices that borrowers make to repay loans. On the other hand, the authors caution against automatically concluding that a struggle to repay loans means the loans are making those borrowers worse off.

The authors also investigate the results of six empirical studies that have tried to quantify over-indebtedness levels and over-indebtedness risk. While the levels of over-indebtedness appear distressing across the studies, the study countries were not representative of worldwide microcredit markets as they were selected precisely because of concerns about over-indebtedness.

Finally, the authors offer a non-exhaustive survey of potential responses to over-indebtedness, listing steps MFIs and funders can take to address the issue. MFIs can consider changing product design or modifying the processes for sales, loan underwriting and collection. For funders, the authors recommend an explicit assessment of over-indebtedness risk as part of the evaluation of potential grantees or investees.

Sources and Additional Resources:

Schicks, Jessica, and Richard Rosenberg. 2011. “Too Much Microcredit? A Survey of the Evidence on Over-Indebtedness?” Occasional Paper 19. Washington, D.C.: CGAP, September, available at http://www.cgap.org/p/site/c/template.rc/1.9.55377/

MicroCapital.org article, November 24, 2011, “MICROCAPITAL BRIEF: Center for Financial Inclusion Releases ‘Over-Indebtedness of Microborrowers in Ghana’ by Jessica Schicks,” https://www.microcapital.org/microcapital-brief-center-for-financial-incl

MicroCapital.org article, October 6, 2011, “MICROCAPITAL BRIEF: On Financial Access Initiative Website, Daniel Rozas Highlights Roles of Credit Bureaux, Smart Campaign, Local Regulations to Address Multiple Borrowing in Microfinance,” https://www.microcapital.org/microcapital-brief-on-financial-access-initi…

MicroCapital.org article, February 2, 2011, “MICROCAPITAL PAPER WRAP-UP: Over-Indebtedness and Microfinance: Constructing an Early Warning Index; by Vivien Kappel, Annette Krauss and Laura Lontzek; published by Center for Microfinance, University of Zurich, responsAbility Social Investments AG, Triodos Bank and Council of Microfinance Equity Funds,” https://www.microcapital.org/microcapital-paper-wrap-up-over-indebtedness

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