>Posted by Kirsten Hansen
I once had a roommate who stored her credit cards in the freezer. When I asked her why she was hiding her Visa between packages of frozen peas and ice cream she explained that by “freezing” her credit cards, she would not be tempted to use them.
Unfortunately for lending institutions, many borrowers do not have the discipline (or perhaps the creativity) of my former roommate in confronting the temptation to overspend. In fact, the recently released 2012 “Microfinance Banana Skins: Staying Relevant”, a survey of practitioners, investors, regulators and observers in the field of microfinance, found that overindebtedness among borrowers is now seen to be the most urgent risk in the field of microfinance. Overindebtedness has replaced credit risk, which was ranked as the top concern in the 2009 and 2011 surveys. Although the overindebtedness and credit risk are very closely related, according to authors of the report, the shift to the former reflects new concerns about the state of microfinance.
Survey participants’ responses revealed that the fear of over-indebtedness stems from multiple sources such as;
- MFIs’ failure to conduct adequate credit analysis of borrower
- Inability or inefficiency of credit bureaus to provide information about borrowers’ credit worthiness
- Over-expansion of the microfinance industry
- Rise of competition between MFIs
- Absence of information available to clients
- Overall need for enhanced financial literacy on the part of borrowers.
Although overindebtedness is a ubiquitous concern, a closer analysis of the results reflects the adage: “where you stand depends on where you sit.” Practitioners who run or work in MFIs, were most concerned about overindebtedness. Investors, regulators, and observers also worried about overindebtedness, but listed institutional problems of effective corporate governance and management quality as their greatest concerns.
Geography, it seems, plays a lesser role. Overindebtedness is of great concern in Latin America, Central and Eastern Europe, the Middle East and North Africa. Notable exceptions are Asia and Africa, where political disturbances and liquidity troubles overshadowed concerns about overindebtedness. But these and other perceived risks, such as management quality and the role of regulation, tended to be more localized risks, whereas overindebtedness is causing apprehension worldwide.
The “Banana Skins” report correctly emphasizes that the survey examines perceived, not actual risks. Nevertheless, the perception that overindebtedness is a threat to the microfinance industry is rising, and this perception has the potential to impact the reputation of the microfinance industry. As more people come to view overindebtedness as a risk in microfinance they are apt to question whether MFIs are more concerned with serving their clientele, or in expanding their client base, meeting business targets and making a profit.
Whether a real risk or merely perceived, the fear of overindebtedness highlights a great irony in microfinance: consumers who once had no access to financial services may now have too many financial obligations. Addressing this dilemma requires understanding the fundamental interdependence of lenders and borrowers. In the increasingly complex financial system, both lenders and borrowers stand to reap enormous gains, but each must play their part. MFIs should be diligent and conduct adequate checks on borrower’s credit history and transparent in educating clients about products and services. Clients should be forthright in providing information about their credit circumstances, and realistic about their respective abilities to pay back a given loan. If necessary, they should take a page from my roommate’s book and find a way to “freeze” their own temptations to use credit for unnecessary spending. Otherwise, the credit MFIs provide could become too much of a good thing.
Have you read?
Let’s Actually Talk about Money Management
What the Microfinance World Could Learn from Autism Therapy
CFI Publishes ‘Over-Indebtedness of Microborrowers in Ghana’ Report by Jessica Schicks