Rethinking Multiple Borrowing
By Daniel Rozas,
Microfinance Focus, September 15, 2011: Some time ago, I had a conversation with a microfinance investor. What is the greatest challenge facing the sector? – I asked. His answer: multiple borrowing – multiple borrowing getting people into too much debt; multiple borrowing transforming micro-enterprise lending into consumer finance; multiple borrowing rewriting the traditional relationship between MFIs and their clients.
Of course, multiple borrowingis present in all of these cases. But thinking about multiple borrowing along these lines misunderstands the basic situation. Multiple borrowing isn’t a reflection of some recent or extreme developments to be ascribed to runaway growth, greed, or willing ignorance. Nor is it some foreign element to be excised from microfinance. No, multiple borrowing is an intrinsic part of the practice, one that has been with us for years. Nor, despite press articles to the contrary, is it a result of heavy market penetration, or even saturation.
This is a realization I came upon during a recent trip to Haiti. Haiti, you see, is a relatively unpenetrated market, with peak numbers on MIX showing about 120,000 borrowers, or about 1.2% of the population. And yet the feedback from loan officers on the ground was that multiple borrowing is widespread, some suggesting that as many as 50% of their clients have loans with other MFIs. And this wasn’t a case of saturation in one place and nothing elsewhere – I heard similar stories both in the capital and in the regions.
Haiti is full of informal markets and businesses that make up the heart of a traditional microfinance portfolio. Demand is clearly there. But given the spread of multiple borrowing, the true penetration numbers suggest less than 1% of the population – far below the numbers of other (stable) microfinance markets. This level of penetration is very low indeed.
Now, a disclaimer – nothing I heard warrants outsize concern about the potential ill-effects of multiple borrowing. Haiti faces a host of problems, but a credit bubble in its microfinance sector isn’t one of them. Still, the spread of multiple borrowing took me by surprise.
But really, why should I have been surprised? In theory, microfinance should feature more, not less, multiple borrowing. After all, traditionally the sector targets individuals without documented credit histories, and this is still largely the case in most countries. For MFIs, the most costly loans are for new clients, whose repayment histories aren’t known. Such “first cycle” loans tend to feature especially low balances (which are costly to serve), and their repayment rates tend to be lower than those of more mature clients.
Clearly, if one could get some evidence of timely repayment, even from an existing loan, the returns for that in terms of lower risk and lower cost will nearly always outweigh the added risk of the additional debt burden on the client. And this is even more true for the near term – the financial effects to the MFI of over-burdened borrowers tend to take time to manifest themselves, and often don’t appear until the borrower is very deeply in debt or when the entire market hits a crisis level.
Yet in the long-run, such an approach is a losing proposition to the industry, hurting both the clients and the MFIs. My recent study of MFIs in crisis – Weathering the Storm – featured two MFIs (“Hestia” in Pakistan and “Phaethon” in Morocco) where multiple borrowing was a key component of the institutions’ uncontrolled growth path that ended in their eventual collapse. There are, of course, many other such cases (Bosnia, Nicaragua, Andhra Pradesh), and these are now well-understood by the industry – hence the focus on preventing over-indebtedness and the runaway success of the Smart Campaign in bringing this issue to the forefront of the sector’s consciousness. But this recognition doesn’t appear to have come with the realization that multiple borrowing is an industry norm. Some continue to reject the practice altogether. One large MFI in Azerbaijan has been promoting a one-loan, one-lender policy.
These are understandable and even laudable positions. Unfortunately, they run against the inherent dynamics of microfinance. The most sustainable answer isn’t to avoid multiple borrowing, but to recognize it, understand it, and ultimately, manage it better.
Living with multiple borrowing
The first and most common response in the sector has been two words: credit bureau. And it’s of course the right one, since this can be one of the key tools in assessing a client’s existing debt burden. But credit bureaus only provide the information – they can’t by themselves change lending practices or perceptions. And they will do nothing to help with the loss-making economics of first-time borrowers. If anything, one can expect multiple borrowing to increase with the introduction of credit bureau data, which improves MFIs’ ability to target clients with existing repayment histories, that is to say, with existing loans.
In truth, the most appropriate response is the one the Smart Campaign has identified – preventing over-indebtedness. Yet it’s also a more difficult response than setting up a credit bureau. The problem, as is so often the case in microfinance, is that it’s not a response that can be effectively implemented by any one MFI. The most obvious example of this is the case of the “bad actor.”
Consider two MFIs: Jerry Community Bank and Tom Loans. Jerry diligently evaluates the repayment capacities of its clients. In fact, it’s so good at evaluating clients that its portfolio becomes perfect pickings for Tom, an MFI on the lookout for clients with good histories. That’s the main reason Jerry has been reluctant to report its data to the new Credit Bureau, since it fears that Jerry would simply use the information to steal its clients.
But besides keeping Tom away from its clients, Jerry has another problem. It has committed to prevent its clients from becoming over-indebted – a principle it believes in strongly. But it has increasingly been finding itself at a crossroads. When its clients seek to renew their loans, Jerry learns that they have also borrowed from Tom, and for some, renewing the loans would put their total debt burden above the level deemed acceptable to Jerry. So what’s Jerry to do? Turn these clients away? Lecture them against borrowing from Tom? Or avert its gaze, and renew the loans?
Jerry’s dilemma has no good options. What makes it particularly insidious is that staying true to its principles and refusing to relend to clients who have over-borrowed from Tom would throw Jerry into financial turmoil, as it would now be in a position of absorbing the high costs of new client evaluation, only to lose many of them to competitors facing no such costs. Averting its eyes and continuing to lend is risky too, but that risk is more remote. Most clients will continue to pay, at least for the foreseeable future.
Reality is rarely as stark as the struggle between Jerry and Tom, but elements of this dynamic can readily be seen in microfinance markets the world over. And given the options above, it’s no surprise that most Jerrys of the microfinance world, when pressed, put aside their principles and choose institutional survival, namely averting their eyes to over-indebtedness and continuing to lend. And notice that this situation develops regardless of whether a credit bureau exists or not.
Escaping the vortex
The only sustainable means of avoiding such a dynamic is to seek an outside force that balances out the market, making Tom’s strategy too costly to pursue. One such force is regulation, specifically client protection regulation that requires lenders to demonstrate that they have taken reasonable steps to verify that the client is able to repay the debt within accepted norms. Some countries have this, but most do not. I suggest the latter may want to study the success of the former.
There is also another way: make Tom’s funding so costly that it will no longer have an economic incentive to take such an approach. This is now happening. Many foreign investors have signed on to the Smart Campaign’s client protection principles, including prevention of over-indebtedness. The key to this is vigilance – every MFI would be required to demonstrate that it has evaluated clients’ repayment capacity according to specified norms and taken related steps (such as not overemphasizing new client acquisition in its incentive scheme). Those whose lending methodology cannot be thus certified would lose access to a large part of microfinance funding, and would become limited to local markets only. Exceptions could be made for young/small lenders, whose impact on local market dynamics is in any case minimal.
Microfinance is a sector where such self-enforcement might just work. The Smart Campaign is working to develop a process for certifying an institution’s client protection practices. The standard would then become a natural filter for funds, and funds’ own reporting on compliance rates would become a filter for investor capital. The result could be a powerful force for shaping lending practices. After all, most foreign microfinance investors expect to see positive social returns, and one can reasonably expect that most would use such certification as a key criterion in their investment decisions.
There would still be holes left. Institutions with little dependence on foreign capital would still be able to operate outside these lending standards. In some cases, such institutions may be large enough to dominate local markets. It such situations, the sole answer is appropriate regulation. To that end, concerned MFIs, investors, and industry advocates should be actively involved in lobbying for local regulator support.
Such efforts could well yield fruit, and in the end, perhaps Jerry Community Bank will find itself in a more sustainable market dynamic than having its clients chased endlessly by Tom Loans.
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Note: This article was first published on the Financial Access Initiative: Link
Hi Daniel, you are touching upon a crucial aspect of micro finance. The biggest risk in micro finance is clearly over lending beyond a client’s ability to repay. This arises principally because it is an unsecured loan and hence the tendency to over borrow is always high. While u have suggested the Smart Campaign as a suitable panacea, yet it fails in being too generic and ‘good in spirit’ but low on content. Also who is going to oversee its actual field level implementation? Even if an MFI subscribes to the policy, how is one to ensure it is being followed by that MFI across all its millions of transactions?
I would like to suggest what is now emerging in India as an alternate package for managing this risk. In India, we have a regulation by RBI that all MFIs put together cannot give a loan of over Rs. 50000 (about $1100) to one borrower. MFIN, our association, has a code of conduct which limits a maximum of 3 MFIs who can extend loan to one client. Combining these two, we have now a regulatory framework which lays down that not more than 3 MFIs can extend loan to one borrower and all three of them put together cannot extend beyond Rs. 50000 to such borrowers. And given the income profile of these clients and their income generating capabilities, it is generally believed that this cap would ensure that almost all borrowers would be able to meet their debt obligations.
Now the next question is how is the implementation of this by all MFIs in the field, to be monitored? Here also we are going by a combination of 3 factors.
Factor 1: There is a good and functional credit bureau operational in India and almost 80% of NBFC-MFI data has already been uploaded. We have started taking client reports whenever a person approaches us for a loan, check their existing borrowings and number of MFIs and then if it is within the above regulatory ceiling, then only extend loan. In a few more months, we hope the rest of the NBFC-MFIs would also be part of this process
Factor 2: MFIN, as the SRO will play its own role to ensure its members follow these guidelines. The Board of MFIN has recently approved a 4 tiered approach to monitor field activities of its members viz: (a) self report by MFIs on their compliance, (b) verification by peer MFIs and reporting back to MFIN committee any irregularities they observe with respect to other members, (c) verification by staff of MFIN, randomly from time to time and (d) appointing internal auditors by MFIN Board who would be given the task of doing random sampling surveys across the country on all its members across the country and reporting back its findings.
Factor 3: There is an equal pressure being applied on bankers, that before they extend loan to any MFI, they should make it mandatory for such MFIs to contribute their data to the bureau and also compulsorily down load reports and check overall borrowings before extending fresh loans. Also banks would be required to do a random audit of the files of borrowers maintained by MFIs to ensure compliance with this
The combination of all the above initiatives, we are fully confident, would reduce the risk of over lending in the Indian MFI sector to a level which would be acceptable to all stakeholders. The question of course, is whether this is possible in reality. Well, as a sector, we have delivered on our promise of credit bureau, so there is hope we will deliver on the rest of the above too!
Regards/vasu
Thanx for a thorough analysis for the issue. A couple of comments:
1) what you rightly explained about the dilemma of Jarry and Tom is the same dilemma international investors unfortunately have.. when there is a very small number of well performing MFIs in a country, they all compete to lend/invest in those MFIs and though they signed the smart campaign, they or they will eventually close their eyes and lend to the MFI to stay in the business.
2) you did not touch enough on the role of financial education for the client in this regard.. It will not solve the problem but can dilute it as some clients when they understand where over indebtedness would take them and take their families and enterprises etc.. might rethink twice before doing it.
3) not sure how serious self regulation has been so far.. would be great if you can provide cases where self regulation has worked
thanx again
Dear Vasu,
I’m with you 100%. From my perspective, effective client protection regulation mandated by government is far preferable to self-regulation. And the mechanism you currently describe where MFIN operates within a framework of regulatory requirements set by RBI is very much along the lines Sanjay Sinha and I had proposed nearly two years ago (https://www.microfinancefocus.com/experts/avoiding-microfinance-bubble-india-self-regulation-answer). While I’d have preferred seeing this framework come into being without the cataclysmic events in Andhra Pradesh, I think there’s nevertheless real hope for the future. Perhaps this was the only way of getting there…
Regarding my point on the Smart Campaign, the notion was less on MFI promises and more on a standards-based framework that the Campaign is currently working on. This would entail a certification by an independent 3rd party (such as a rating agency) that would validate the MFI’s operations against a fixed standard (think a standard like the Fair Trade label, for example). My hypothesis is that when funding is dominated by social and development-oriented investors, such a label would become a de facto requirement, much like government regulation. However, this applies much more to markets where foreign investors predominate, and is thus less relevant to a market like India, which is funded mostly through domestic funds.
I think the same applies also as an answer to Khaled’s comment. Investors would seek out investment funds that invest only in those MFIs that carry the Smart certification label, which would then become the driving factor in those funds’ portfolio selection.
Daniel
The whole analysis misses some points.
Livelihood financing into which MFIs are – is financing to people just for their basic sustenance- whatever name we gave it, a way of redistributing money for bare survival.
So, in case of monsoon failure or business failure or personal sickness, livelihood or survival is still to be financed until the next healthy day or next monsoon or next business cycle, for which even an over-indebted borrower or overextended borrower deserves to be financed, in case the loan has ever to be repaid at all.
Else we can blame and write off the loan and have the regulator in place to support us but we have the two options:
1)give a bad name and shoot the borrower, spoil his credit history etc
2)finance the borrower till he becomes a viable borrower
the more economically sensible thing would be to rather extend the loan till the borrower becomes viable once again.
Dear Vasu,
I think your point is interesting, however I would argue that clients don’t go to multiple borrowers necessarily just because they can, but also because they have a specific need. For instance, lets say I have a food business and I want to buy a refrigerator so I can sell my food over a number of days and not have it spoil.
The refrigerator costs $1,000, however analyzing my repayment capacity MFI A can only lend me $900 and not the $1,000 that I need, so I go to MFI B who agrees to lend me not the $100 that I need but $300 more! Now, MFI A might have been too risk averse and MFI B might be following a different standard. How do you reconcile that?
Also, I understand your point that in India the bar was set at $1,100 (Rs. 50,000). Should MFIs that have seen their clients grow and prosper loose them because they can’t lend over that amount? Should they instead turn their good clients into Bank clients?
Just a couple of thoughts.
Sergio
In India poor people borrow at high rates of interest from private money lenders and finance companies which are outside the purview of any regulator or law. There is usually no documentation nor proof of having borrowed or lent money. Brute force, social pressure are the key factors in recovery. Usually the lenders have the local caste elders and local leaders in their grip who are ever ready to mete out kangaroo justice. When a loan with interest rate of 60 % p.a. is repaid with a loan of say 24 % given by an MFI, it comes as a great relief to the hapless borrower. The only advantage in such high interest loans is flexible repayment of principal and interest. When MFIs emerged in Andhra Pradesh, they had a run away sucess for reasons cited above . But when their repayment terms were rigid, they had to face a backlash.
Dear Daniel,
I cannot see the advantage of having a third institution evaluate the capacity of an MFI to lend to their (informal) clients (with “informal clients” I mean clients with informal accounting standards, or no accounting standards at all…I just never was clear about the expression of “micro clients”, so I prefer to avoid it).
The main reason is, in short, that I don’t believe that this third institution as you (and the Smart Campaign) propose it actually has the capacity itself to evaluate the above-mentioned lending activity. In the worst case, this proposal could lead to a situation in which MFIs with enough experience to lend in a responsible way would actually have a hard time to access to capital, simply because it doesn’t comply to specific standards (which could only be relevant for other industries (e.g. mortgage lending)).
Take Nicaragua, for instance. The Capital Market Supervisory Institution (the so-called “SIBOIF”) has already tried to establish such criteria for regulated MFIs. The experience was that many MFIs saw themselves confronted with norms that actually were unnecessarily limiting: mortgage-lending practices in establishing collateral resulted much too strict for the market these MFIs were attending, and many clients would not have been served because of these norms…by the way: this included also repeated clients, so that not even these clients could have been attended. Thus, the consequence was that the norm was “softened”, i.e. simply adapted to the reality of this market. The cost of potentially losing “good” clients, though, was high.
In this sense, many questions arise to me when you propose that
“The key to this is vigilance – every MFI would be required to demonstrate that it has evaluated clients’ repayment capacity according to specified norms and taken related steps (such as not overemphasizing new client acquisition in its incentive scheme). Those whose lending methodology cannot be thus certified would lose access to a large part of microfinance funding, and would become limited to local markets only. Exceptions could be made for young/small lenders, whose impact on local market dynamics is in any case minimal.”
Who will decide which criteria will be set in such norms? Will these norms consider that the market is very differentiated (e.g. group vs. individual lending, agricultural vs. commercial lending, micro vs. SME-lending)? Is the “certification” of these institutions a condition sine qua non for external funding? If so: what about institutions that take deposits and actually do not depend so heavily on external funding?
In this sense, I believe the argumentation presented here in favor of such a centralized control is too general. I am therefore convinced that the market should not be conditioned to a “certification”, and that aspects such as Credit Technology and the respective preparation of Loan Officers play a much more important role to avoid over-indebtedness.
By the way: I am somewhat surprised by your comment that:
“Such “first cycle” loans tend to feature especially low balances (which are costly to serve), and their repayment rates tend to be lower than those of more mature clients.”
I cannot confirm that this a general tendency. My experience is that also many repeated clients have not been able to pay back loans. But this, once again, was mainly given to wrong decisions taken from the side of the MFIs, not so much the fact that these were new or repeated clients.
Regards,
Carlos Pumar
Reasonably good thoughts, BUT developing a GOOD & functional credit bureau is bigger issue than the problem itself, moreover it has a long gestation. The millions being quoted is still incomplete – as a major part of the system has not responded yet in India – MFIN is not all ? Further, it only captures the institutional credit and not informal credit , which still thrives in hinterlands . Even if it captures it does for individual credit and not the family credit …in many markets , the household is the unit and not mere individuals in a HH………complexities in name etc is another bigger issue.
I feel the user owned systems are better tuned to manage & addresses these issues better !!
Cheers
Suran
It is common perception in developing countries like India that poor artisans and farmers need adequate and timely credit,cost of credit is irrelevant. It is just taking advantage of financial illiteracy of poor people as cost is relevant to poor more than rich people.
The various complexities of micro credit management in both demand and supply side cause unethical multiple borrowing and multiple lending activities in poverty sector .. For this phenomenon both the institution (unhealthy competition) and the client (unethical practices ) in the presence of multi agencies in the market, are responsible as each player tries to maximize their own self interest without much concerned with ultimate purpose of this micro finance (poverty reduction).Among causative factors for debt stress ,even five minutes of Ad in TV media also fuels the propensity to consume leading to over consumption/conspicuous consumption and multiple borrowing in poverty sector. Unlike other MF services like micro savings and micro insurance, micro credit being a double edged weapon is unique to be handled more prudently in the poverty sector otherwise both lender and borrowers are inflicted. Basically the actual demand for micro credit depends on credit absorbing capacity of the given target area and capability of the target group for productive functioning of the credit and repayment Both these criteria influence the extent of genuine penetration of this services and facilitate smooth productive function of the credit products for Income Generation and repayment at client level and prompt recovery and Income Recognition at industry level. This management of micro credit calls for assessment of physical potential in the first followed by potential based credit planning for the given area. in this industry. Further all the MF services such as micro savings, micro insurance and other support services etc need to be integrated with the planned micro credit for sustainable growth of institution and poverty reduction at client level as well. . But quite contrarily at the neglect of basic principles as indicated above , micro credit alone is being dispensed indiscriminately by MFIs without any relation to income generation capacity, and repayment capability of the poor client and the eventualities witnessed include over indebtedness and debt burden for the client and loan delinquency . In this context what is the way forward I share a few points related to the postings here
Daniel Rozas – The role of credit bureau need to be extended beyond assessing client existing debt burden, covering points suggested below. The idea is based on the Lead Bank Scheme and Service Area Credit Plan approach being practiced by Indian Banking sector as directed by RBI. in India. Either Credit Bureau or leading MFI or both in the given area may take the responsibility of the following task
1. For MFI – identify the physical potentials for various credit products in the given service area 2. For clients- formulation of micro credit plan for individuals –Among the potential ones, indentify the products matching to the needs of the client and financial education 3. 1. Possibilities for Debt swapping
2. . Formation of coordination forum among the MFIs and other financial players at district /region level – a)for making clear demarcation of service area for each one of the players b) agreement for exchange of information of their respective clients loan history. c) possibility of loan swapping d) collective approach for arranging with the respective state players to provide physical support services and create conducive environ for productive utilization of micro credit like road, communication, transport , Marketing etc
3. . Advocacy for gentlemen agreement (self enforcement)among the players with adherence to moral and ethical code of conduct in dealing with micro credit issues like Jerry’s dilemma
4. Smart Campaign is very useful certification programme in effecting a disciplined approach for client protection by the institutions there by ensuring social performance in poverty sector .However CPP should not confine to the complaints related to micro credit investment alone. . Under Microfinance platform the canvas need to be enlarged to accommodate other services like micro saving, micro insurance , etc. since all these diversified MF services go a long way to protect the client livelihood sustainably in terms of enhanced income generation and increased welfare. Eventually this would also benefit the institution in terms of good recovery and establishment of long term relation. Smart Campaign should also include systematic feedback on the impact and suggested improvements directly from the sample clients periodically
Nath-
Another missing point- In the case of affected livelihood situation due to business failure, monsoon failure or covariant risk ( natural disaster) the role of micro insurance assumes importance . It is sensible for making the borrower viable through micro insurance services as it facilitate rejuvenate the affected livelihood to a greater extent and help reduce over indebtedness rather than extending further loan for the said purpose. Unfortunately the potential values of Micro insurance in MF arena remains neglected .
Mohammed Khaled-
Yes there is unhealthy and unethical competition among both the investors and lenders only in micro credit related activities under micro finance platform. It is too bad. Why not the investor focus their interest more on Micro insurance services also as it would facilitate protected environ for productive functioning of micro credit and sustained benefits for both the investor/lender and poor client as well. Smart campaign need to include insurance aspects also in their certification . After all Micro insurance is also one of the components of Micro insurance like that of micro credit .and it has more potential for protecting the welfare of the poor.
I agree that Financial education assumes importance but it should be for both the lender and clients as well on the values of potential based micro credit planning and integrated micro financial services without confining to micro credit service alone.
Vasudevan-
I agree the points spelt out for restricting over lending although mostly pertaining to supply side . However in the context of three fourth of asset portfolio mandated for income generation purpose for NBFC-MFIs (RBI) on one hand and maximum limit of all MFI loan not exceeding Rs 50000 for the poor in the given profile of area , How to ensure smooth process of income generation at the client household level which is assumed with high risk. ? Mere provision of micro loan be it Rs 10000 or 50000 it cannot function without adequate supporting facilities (non financial )appropriately for the respective micro credit product functioning, and more likely the process of income generation getting choked at the field level.. Consequently for MFI it would influence the recovery performance and trend in income recognition of their asset portfolio . This fact calls for meticulous micro credit planning for each MFI for their service area and collective endeavor for arranging supporting facilities with state/private development partners. For this said purpose respective MFI operating in the given district may also participate in the existing District Coordination Committee (DCC) under Lead Bank Scheme in all district and sort out field level functioning issues. Further the role of micro insurance in income generation process assumes significance but remain neglected . May I suggest that MFIN need to look into these aspects also as a part of risk management for healthy performance in this sector benefiting both the lender and borrowers as well and ultimately making a dent in poverty canvas
In fine, ‘multiple borrowing’ is not a sin provided it is to be tuned as value added “healthy borrowing” as discussed above leading to sustainable growth for both the institution and the poor clients
Thanks for sharing my views
Dr Rengarajan
I completely agree.If we want to understand the concept of microfinance as a whole, we need to understand the basics of its emergence even when there is a robust financial system vis-a-vis lots of philanthropic funding agencies or programmes are in place. The basics remains the same for most of these self regulated MFIs. But the business vis-a-vis political environment has changed. We still can keep this industry erving the target customers by regulating all ofthem without altering the basics. Repayment terms need to be rigid to have a better credit discipline and continuance of credit delivery to the poor households, whom the formal sytem ignores. If we can keep this industry regulated and invite more player, then open market concept will take care of the interest rate at which these micro loans are being provided to the poor households. There are lot of genuine players in this space, who are creating a lot of financial literacy among the poor households also and the value of this social change can neither be measured or ignored.
Normally customer wants to deal with one organisation. If his requirement is not fully met, he looks out for alternative sources. One of the issue with Microfinance is that it remained small credit offering without much innovation in terms of products being made available. All the current innovations are primarily limited to channel and methods of credit delivery.
If MFIs or lenders start putting their effort towards understanding customers and livelihood needs and structure products to meet the requirmeent in terms of quantum of funding, frequency of cash flow and tenure etc, the need for multiple sources go down. However, if any organisation is not able to complete requirement of customer, customer could be provided with more than one source of funding subject to cash flow ( customer’s ability to pay) and credit information being available ( through credit bureau).
I Like To Say About Borrowers When The All The MFI Is Given The Loan To The Borrower They Shoud Be Her Backroud……. & Also His Capacity.
I think your point is interesting, however I would argue that clients don’t go to multiple borrowers necessarily just because they can, but also because they have a specific need. For instance, lets say I have a food business and I want to buy a refrigerator so I can sell my food over a number of days and not have it spoil.