COMMENTARY
The question of 'over-indebtedness' among clients of microfinance institutions comes up over and over again, and the answer is always a variant on the theme that we really don't know enough to draw reliable conclusions. As a former corporate CFO and someone who has done my share of consultancy in many aspects of emergency and development, I would argue that it is high time the 'experts' came up with a methodology for understanding the industry performance that works rather better.

I have not worked exclusively on microfinance performance at any time during my career, but have been associated with area development analysis where microfinance was one of many initiatives that were in place. My work showed that some places were getting benefit from microfinance, but in other places development was not going well and microfinance was not having much of an impact. My work convinced me that so called 'externalities' were of great importance and could not be ignored.

In a few cases where I have looked 'inside' the performance of a microfinance entity, it has been clear that the people working in the organization were a big factor in whether or not there would be success ... and extrapolating from this it has been very likely that the money profit driven direction of microfinance industry development of the last few years would almost certainly end up with some disastrous outcomes for clients. This is manifesting itself over and over again with reports and anecdotal information about client over-indebtedness.

If we go back to basics ... what is the 'purpose' of a microfinance initiative? If it is to help people to progress out of poverty, then a profit orientation is unlikely to be of much use.
Peter Burgess

CGAP has published a report asking if Microcredit Over-Indebtedness is a Worldwide Problem?

CGAP has just published a study that Jessica Schicks and I have written on over-indebtedness among microborrowers. The paper is not exactly bedtime reading: I’m slightly embarrassed to say that it runs to 43 pages. So some readers may feel like the third grade student whose book review began, “This book told me more about whales than I wanted to know.”

Download the CGAP report

It’s been an interesting exercise to go back over the paper’s detailed discussion and cull out a few conclusions that feel important enough to highlight in a blog. The first big message has to do with the question in this blog’s title. After many years of enviable repayment performance, serious default problems have broken out in recent years in Morocco, Nicaragua, Bosnia/Herzogovina, Pakistan, and Andhra Pradesh in India. Some of this default is probably “strategic”—borrowers who could easily repay take advantage of political or other situations to stop making payments. But much of the default appears to be due to over-indebtedness. (Without going into the complications of defining “over-indebtedness,” let’s just say for now that it refers to borrowers who can’t repay their loans without serious difficulty. Note that this is a client-centered definition, and that it implies that borrowers can still be over-indebted even if they manage to pay off their loans.)

Are these five markets the tip of a worldwide iceberg? Is over-indebtedness a big problem in a lot of other countries? The answer is an unsatisfactory one: no one knows. Jessica and I found only six studies that tried to quantify microcredit over-indebtedness in individual countries, or parts of countries. Jessica is about to publish a seventh. Generally, these studies have found worrisome levels of over-indebtedness, but we can’t generalize from this small sample, because it is highly skewed. Most of the studies were implemented in locations where there were pre-existing signs of problematic debt levels. So Jessica and I don’t know how widespread debt problems are, but we argue that there a strong reasons to treat over-indebtedness as a clear and present danger in quite a few markets.

Which markets? That brings me to the next big point the paper makes. In an increasing number of markets around the world, microcredit has been so successful that the supply of it is catching up with the demand for it. In other words, markets are approaching saturation.

Let’s pause for a moment here, because for many people talk of market saturation seems odd when most of the low-income population still doesn’t have a microloan. This is because there has been a tendency to overestimate the actual demand for microcredit, sometime drastically (as Malika Anand and I argued in a 2008 CGAP Brief ). The reality is that at any given time, many low income people simply do not want a microloan, while others may want a loan but would be likely to have payment problems if they were given one. Still others can’t be served viably with presently available methods. So supply catches up with effective demand sooner than we might think. This was clearly happening in Morocco and Bosnia/Herzogovina, for instance.

Microcredit has some unique features, but it is one of many different forms of retail (that is, household-level) credit. What happens when retail credit markets approaches saturation? As Gabriel Davel (former chief credit regulator in South Africa) argues, when a competitive retail credit market gets saturated, over-indebtedness problems are practically inevitable; they are not just the result of a couple of rogue lenders’ irresponsibility. Foresight and preparation can reduce the severity of the problems, but problems there will be. This blog is already long enough, so I will refer readers to the paper if they want an explanation of why this happens.

In a nutshell, one microcredit market after another is entering into a new, uncharted world of credit saturation. In these markets, over-indebtedness will probably pose a major risk for clients, not to mention the lenders. As I said, a clear and present danger. Yet in most places we are flying blind right now. This is unacceptable, at least if client welfare is still our core goal. In a later post I’ll talk about the paper’s biggest policy recommendation: that we need to focus urgently on developing early warning systems, so that we are not caught unawares the way lenders and regulators were in the five problem markets I mentioned at the beginning of this blog.

–Richard Rosenberg