Recent research on the <a href="https://www.centerforfinancialinclusion.org/making-digital-credit-truly-responsible">state of the digital consumer credit market in Kenya</a> has documented breakneck growth in mobile lenders and alarming levels of defaults and delinquency. These findings, coupled with <a href="https://www.bloomberg.com/news/features/2020-02-12/tech-startups-are-flooding-kenya-with-apps-offering-high-interest-loans">anecdotal reports</a> of aggressive sales tactics, abusive debt collections, and unacceptable levels of debt stress, raise an enormous red flag regarding digital consumer credit’s potential for financial inclusion.

The promise of digital credit is to make people with no documented financial history visible to the formal financial system, helping low-income people gain access to loans and other financial products. Microcredit started out with a similar promise to help people move out of poverty, but the microfinance industry learned the hard way that good intentions are insufficient. After microcredit-fueled, <a href="https://www.cgap.org/sites/default/files/CGAP-Focus-Note-Growth-and-Vulnerabilities-in-Microfinance-Feb-2010.pdf">overindebtedness crises</a> spiraled out of control, the industry introduced protective measures and formal regulation followed in many countries. The red flags appearing in Kenya’s digital credit market are familiar, but a host of new players beyond traditional banks and microfinance providers may not recognize the signs of a looming crisis.
<h2>New Entrants, New Credit Models</h2>
New tech players are flooding into markets like Kenya to offer scalable models for faster and more accurate loan products backed by big data. Mobile app-based lenders use nontraditional data to provide near-instant credit decisions for loans ranging from the equivalent of $5 to $100. The algorithms at the core of these products rely on unverified, self-reported user information and data scraped from users’ mobile phones, including call logs, contacts, location, social media activity, and text messages. An inherent flaw in these models is that they are built on data reflecting a consumer’s willingness to repay rather than their ability to repay. This is a crucial distinction representing the difference between a client that is willing to skip meals or borrow from other lenders to repay the original loan and a client that can afford the loan without experiencing such debt stress. Repayment rates may appear acceptable, but this flaw in the model masks a brewing overindebtedness crisis as repayment rates don’t account for loan stacking or abusive debt collection practices.

&nbsp;

It’s Time to Protect Kenyans from a Digital Lending Laboratory

Kenya

Sub-Saharan Africa

Client Treatment

Complaint Resolution

Consumer Protection

Over-indebtedness

Responsible Digital Finance

Blog Post

In the past few months, questions have been raised about the quality of microfinance debt collection practices in Cambodia. A damning recent <a href="http://www.licadho-cambodia.org/reports.php?perm=228">report</a> by LICADHO, a Cambodian human rights organization, concluded that MFIs in Cambodia have relied on “inadequate government regulation and the widespread complicity of local authorities” to unethically and illegally force indebted Cambodian borrowers to sell their land titles in order to secure repayment. Borrowers, unaware that land seizures are illegal, are intimidated into doing so. Interviewees in the report also indicated other lender abuses, including child labor, debt-driven migration and food insecurity – all because they couldn’t pay loans on time. The report, which the Center for Financial Inclusion recommends reading, raises serious concerns about human rights and consumer protection.

CFI has been an advocate of consumer protection in Cambodia for <a href="https://www.cgap.org/blog/supporting-client-protection-cambodia">many years</a>, working with a variety of stakeholders in the country, including donors, financial service providers, clients and the government. We believe that using threats as a means to extract repayment is unacceptable, and the allegations from LICADHO should be taken seriously and further investigated. Responsible practices should be reinforced by providers as needed.
<blockquote>We believe that using threats as a means to extract repayment is unacceptable.</blockquote>
However, as the report itself and the Cambodia Microfinance Association (CMA) <a href="https://www.construction-property.com/lichado-report-selective-and-misleading-says-cma/">point out</a>, the results need contextualization. The sample size is very small – only 28 interviews were conducted in four provinces and Phnom Penh – and is not meant to be statistically representative of Cambodia or all MFI clients. All interviews were conducted in a very short timeframe: spring 2019. Are a small number of providers concerned, or is the report surfacing issues that indicate an existing (and possibly increasing) general crisis amongst MFI providers? While the issues raised in the report merit attention, even if they affect a proportionally small number of clients, it is important to understand the scope of the problem in order to determine how to adequately address it.

The <a href="http://smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles">Consumer Protection Principles</a> contain strict guidelines that deter providers from violating borrowers’ human rights. Consumer Protection Principle 5, which concerns the fair and respectful treatment of clients, strictly prohibits Smart-certified financial service providers from using abusive language, using physical force, limiting physical freedom, shouting at the client, entering the client’s home uninvited, publicly humiliating the client, violating the client’s right to privacy, mistreating a client based on any protected groups, using intimidation or threats, sexual or moral harassment. Guideline 5.3.3 explicitly states that “the provider staff may not force clients to sell their own collateral to pay off their debt.”

But it’s not about just setting principles and hoping providers abide by them. The <a href="http://smartcampaign.org/certification">Smart Certification</a> process requires financial service providers to demonstrate their adherence to the Client Protection Principles and corresponding standards. It represents a rigorous analysis of an institution’s policies, systems and practices, carried out by licensed third-party organizations. Recognizing that organizations, regulations and product offerings evolve, our 115 certified-organizations worldwide are required to be recertified every four years, with a two-year check-in, and a required recertification if the organization goes through material change. Certification is a measure of whether an institution has adequate systems in place to prevent client harm, ensuring that harm isn’t occurring, and mitigate it if it is. The Cambodian microfinance sector, with support from CMA, has worked hard over the years to improve practices in order to meet the rigorous bar set by Smart Certification. Eight Cambodian institutions are currently Smart-certified: LOLC, Acleda Bank Plc, AMK, Hattha Kaksekar Ltd., Amret Microfinance, Sathapana Bank, VisionFund Cambodia, and Thaneakea Phum.

Through the assessment and certification process, widespread client abuses come to light and the institution is given recommendations on how to address them. On the other hand, one-off poor and abusive decisions on the part of selected individuals may not surface. This is why complementary research of alleged abuse, and the presence of well-functioning recourse mechanisms for clients are critical.
<h2>CFI's Role in Cambodian Consumer Protection</h2>
CFI started its engagement with the microfinance sector in Cambodia in 2012, a time when the Cambodian market, a victim of its own success, was growing at a pace seen by many as unsustainable: between 2004 and 2014 the growth in the average household loan size <a href="https://cma-network.org/files/OIDWORKSHOP/MIMOSA Circular Cambodia Jun 2016.pdf">outpaced growth</a> in average client income by a factor of four. CFI convened key funders of the main MFIs and encouraged them to embrace Smart certification as part of their screening and due diligence process to ensure that providers had adequate policies and practices in place to prevent over indebtedness and poor client treatment. In the years that followed, and with generous support from the Agence Francaise de Développement (AFD), CFI supported an ambitious consumer protection program aimed at developing the country’s credit bureau, strengthening the capacity of the Cambodia Microfinance Association (CMA) and improving practices of the main financial service providers (FSPs) to the poor in the country.

FSP practices drastically improved as part of this work. Collectively, the eight Smart Certified institutions in Cambodia serve 1.6 million clients. This is an incredible achievement for the sector, as these clients are served by institutions that have committed (and demonstrated) that they have put in place systems and processes to protect their rights and treatment. Preventing over indebtedness is complex, especially in the context of fast-growing markets and an environment where lenders are not always required to report to the credit bureau.
<blockquote>The eight Smart Certified institutions in Cambodia serve 1.6 million clients.</blockquote>
<h2>Lending Guidelines</h2>
As concerns of over indebtedness have continued to <a href="https://mimosaindex.org/inexorable-growth-in-cambodia-like-a-rolling-stone-2/">rise over the years</a>, concerned players decided to go a step further and understand better the underpinnings of growth in the Cambodian market, as well as ways to ensure a responsible growth. Since 2016, the <a href="https://cma-network.org/">CMA</a>, <a href="http://www.incofin.com">Incofin</a>, <a href="https://mimosaindex.org/">MIMOSA</a>, the Credit Bureau of Cambodia, the Smart Campaign at CFI, and several other stakeholders have been developing and refining the CMA Lending Guidelines. The <a href="https://www.microcapital.org/special-report-a-model-from-cambodia-for-preventing-overheating-not-just-multiple-lending-to-be-presented-at-european-microfinance-week-november-14-16-2018/">project</a> was funded by Incofin, <a href="https://www.proparco.fr/en">PROPARCO</a>, BIO, <a href="https://www.fmo.nl/">FMO</a> and <a href="https://www.ada-microfinance.org/en">ADA</a>.

The Lending Guidelines, published in 2016 (overview <a href="http://www.e-mfp.eu/sites/default/files/resources/2018/11/Preventing overindebtedness in Cambodia_all speakers.pdf">here</a>), were developed because the industry in 2015 was growing at an average of 25 percent per year, even as the number of loans remained unchanged at 2.3 million. This meant that the same clients were taking more debt when their loans were renewed, even though their economic activities did not justify it. The average loan size had almost doubled, growing from close to $1,700 to a little over $3,000 with loan maturity of four to five years (the GDP per capita in 2017 stood at around $1,400). The Lending Guidelines have identified excessive and reckless refinancing as a key concern area for the lending sector, and recommend maximum thresholds for refinancing, above which lenders are bound to more scrutiny. They include a mix of indicators highly correlated to over indebtedness, such as multiple borrowing, loan to income ratio, and refinancing rates.
<blockquote>The Lending Guidelines have identified excessive and reckless refinancing as a key concern area for the lending sector.</blockquote>
The FSPs that have endorsed the lending guidelines have adapted their credit their underwriting policies and enhancing their risk management practices. The National Bank of Cambodia (NBC) has been supportive of the Lending Guidelines and has made public statements on calling FSPs to adopt them. The Central Bank of Cambodia issues a monthly dashboard that shows the FSPs level of compliance with the Lending Guidelines. The Lending Guidelines have been fully integrated into the Smart Certification process and not abiding to the Lending Guidelines can be one of the causes for not having a Certification renewal. The Lending Guidelines are reviewed to ensure that they are meaningful in curbing the risk of over-indebtedness. The Lending Guidelines are an example of a market defining precise recommendations to address a specific issue occurring in a market (here, excessive refinancing). As other issues surface and are demonstrated (i.e., intimidation and illegal land seizure), additional monitoring and mitigation strategies can be put in place at the market level to address systemic issues and complement the individual work of responsible providers.
<h2>Next Steps: Improving Regulation and Learning From Clients</h2>
I recently traveled to Phnom Penh to attend a closed meeting of regulators, hosted by the NBC and supported by Asian Development Bank, to discuss how authorities can improve oversight. There were a few key takeaways from this. Even though the NBC is actively working on draft consumer protection regulation, current financial consumer protection regulations are weak. The National Bank of Cambodia is dependent on the CMA to mitigate the risks that are looming over the sector. There is, however, an initiative in an initial phase to create a registry of collaterals, assets, and fixed values. Overall, it’s encouraging to see that there’s consensus on the necessity for more sensitization of regulators on consumer protection, as the national financial inclusion strategy is more heavily focused on credit report sharing. The CFI is excited to work with the NBC, drawing from the <a href="https://www.smartcampaign.org/tools-a-resources/1210-handbook-on-consumer-protection-for-financial-inclusion">Handbook on Consumer Protection for Financial Inclusion</a> (recently updated to reflect the risks to consumers in a digital financial world) to improve the Cambodian regulatory framework.
<blockquote>It’s encouraging to see that there’s consensus on the necessity for more sensitization of regulators on consumer protection.</blockquote>
In addition to improving the regulatory framework, we must have better and more frequent ways to hear from clients directly.

With this in mind, we ask: is collateralized debt seizures a troubling and growing trend, or was the LICADHO study reflecting isolated incidences of mistreatment? We hope that a new study initiated by CFI will help shed light on the issue. The study, known as Client Voice, uses an interactive voice response (IVR) approach. Three Smart Certified FSPs – AMK, Maxima and HKL – will participate, and 500 to 1,000 clients from each institution will be surveyed. Institutions that are at the stage of transforming to digital product offerings – such as AMK – are looking to adopt new and better ways to gather ongoing feedback from clients to improve their product design and delivery and are keen to test the IVR system to that effect. The study will be completed by December 2019, and the results will be published by January 2020.

Land Seizures and Reported Abuses in Cambodia: CFI Responds

The Smart Campaign

Cambodia

East Asia and Pacific

Enabling Environment

Financial Inclusion Strategy

Policy, Regulation and Government Initiatives

Smart Certification

Digital credit has emerged as a new and profitable service offering that has great potential to increase financial inclusion. Yet, if not carefully managed, digital credit also runs the risk of excluding, over-charging, and over-extending customers.

Seven years since the first digital credit product launched, the market in Kenya has grown exponentially and hosts a diverse ecosystem with more than 50 supply-side actors. The phenomenal expansion of digital credit in Kenya serves as a test-bed for the product and offers lessons for digital credit suppliers and regulators around the world.

SPTF and the Smart Campaign commissioned MicroSave Consulting (MSC) to study the dynamics of the digital credit sector on both demand and supply sides. The output of the study was a <a href="https://content.centerforfinancialinclusion.org/making-credit-truly-responsible-webinar/">comprehensive report on the current state of digital credit in Kenya</a>. It looked at the evolving challenges in digital credit and made recommendations for a more responsible and customer-centric delivery of the product.

With participation from Smart Campaign Senior Director Alexandra Rizzi, this webinar:
<ul>
 	<li>Helps participants understand the digital credit landscape in Kenya</li>
 	<li>Assesses the progress and challenges around making digital credit responsible and inclusive</li>
 	<li>Recommends steps towards a more responsible delivery of digital credit</li>
</ul>

Making Digital Credit Truly Responsible Webinar

SPTF

Credit

Credit Provision

Customer Centricity

Default

Delivery Channels

Digital Financial Services

Financial Service Providers

Interest Rates

Nano Loans

Product Pricing

Webinar

All is not well in the country that pioneered mobile credit. A new <a href="/making-digital-credit-truly-responsible">report on digital credit in Kenya</a> from <a href="https://www.microsave.net/">MSC</a>, commissioned by <a href="/about/what-we-do/the-smart-campaign">the Smart Campaign</a> and the <a href="https://sptf.info/">SPTF</a>, shows that with continued dramatic growth rates, the sector also experiences cripplingly high default and delinquency, enabled by poor business practices and weaknesses in both the credit reporting infrastructure and regulatory jurisdiction.

Most notably, the report reveals very high rates of delinquency and default. Among active digital loans, more than a quarter are non-performing. About 2.2 million Kenyans are said to have delinquent loans. In some cases, liberal use of refinancing and rescheduling hides this level of delinquency in lender portfolios. At the same time, the report points out that about half of these non-performing loans are for amounts less than $10. These findings are broadly consistent with results cited by CGAP in 2016, which found that 50 percent of digital borrowers in Kenya repaid their loans late, and 12 percent defaulted.
<blockquote>Despite continued growth of digital credit in Kenya, high delinquency, default and interest rates persist in the market and credit bureaus haven't yet caught up with the digital age.</blockquote>
The report also details shortcomings in credit reporting, given that many digital lenders neither consult nor report to the credit reporting bureau as fully or regularly as they should. The credit reporting bureaus were clearly set up for a pre-mobile era, which suffer from issues related to inclusion of all types of lenders, frequency of uploading data (monthly, when daily is more relevant for today’s short term loans), and ease of connection among all the players in the credit reporting ecosystem. As a result, many lenders are not consistently using credit bureaus—neither ensuring that the information is updated and correct, nor fully consulting it prior to lending.

Pricing is also an issue. The market leader, M-Shwari, which accounts for about two-thirds of all digital loans, charges an annual percentage rate (APR) of 90 percent. The low-price option provided by Kenya Commercial Bank is a fairly reasonable 44 percent APR, but the high end of the price range includes providers charging APRs well into the hundreds. Granted that these are small, short term loans where interest payments are not expected to be sustained for an entire year. Nevertheless, the promise of digital to bring down prices does is not yet in sight.

Other issues noted in the report include non-transparency regarding portfolio quality, identity theft, misuse of client data, multiple borrowing and loan bicycling by clients, and client use of loan proceeds for sports betting.

The picture that emerges suggests that the still-exploding market of very small, “nano” loans needs to be brought into more orderly operation. Consumers and providers are operating in risky ways. The current state of the market is not beneficial for either.
<blockquote>Raising the bar for blacklisting customers and public awareness about defaulting on loans are among our recommendations for improving digital credit.</blockquote>
One issue specific to this nano-loan market concerns the reporting of very small non-performing loans to credit bureaus, with negative consequences, such as curtailing of access to credit, for hundreds of thousands of borrowers. MSC, the Smart Campaign and SPTF recommend that regulations be put in place such that delinquencies and defaults among loans below some fixed amount not be reported to the credit bureau (whether US$2, $5 or $10 – the report actually recommends a cutoff of 5% of the monthly per capita GDP). It also recommends that the government launch a public awareness campaign about how credit bureaus work and the consequences of default so consumers will better understand the risks involved in borrowing.

The regulators, credit reporting agencies and lenders in Kenya are aware of these concerns and working to improve the situation. A new association of digital lenders (Digital Lenders Association of Kenya) has been formed to create consumer protection standards and the central bank is exploring ways to upgrade the credit reporting ecosystem. The Smart Campaign recommends that both lenders and regulators consider adopting the <a href="http://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles/digital-credit-standards">digital credit standards</a> and <a href="https://www.smartcampaign.org/tools-a-resources/1210-handbook-on-consumer-protection-for-financial-inclusion">model regulations</a> covering issues ranging from transparency, to the fair use of algorithms, to protection of customer data.

Kenya’s unprecedented dynamism in mobile money, digital credit and financial inclusion is envied across the world. If authorities and providers can bring the participants in these sectors into a better-functioning marketplace, Kenya will benefit greatly from the innovation the country continues to spawn.

Red Flags in Kenya’s Nano-Credit Market

Keeping Clients First

Digital Credit

Fintechs

Transparency

<span class="hotkey-layer ">Digital credit has emerged as a new and profitable service offering that has a great potential to increase financial inclusion. Yet, if it is not carefully managed, digital credit runs a great risk to exclude, over-charge, and create over-indebtedness.</span>

<span class="hotkey-layer ">During the first half of 2019, The Smart Campaign and the Social Performance Task Force (SPTF) commissioned Microsave Consulting (MSC) to study the current state of digital credit in Kenya and formulated recommendations for how to make digital credit delivery safer and more customer-centric. We propose that </span>regulations be put in place such that delinquencies and defaults among loans below some fixed amount not be reported to the credit bureau so as not to unduly burden consumers. We also call for increased public awareness campaigns about how credit bureaus work and the consequences of default so consumers will better understand the risks involved in borrowing.

More generally, the Smart Campaign recommends that both lenders and regulators consider adopting the <a href="http://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles/digital-credit-standards">digital credit standards</a> and <a href="https://www.smartcampaign.org/tools-a-resources/1210-handbook-on-consumer-protection-for-financial-inclusion">model regulations</a> covering issues ranging from transparency, to the fair use of algorithms, to protection of customer data.

Making Digital Credit Truly Responsible

Agence Francaise de Developpement

Report

Digital credit has emerged as a new and profitable service offering that has great potential to increase financial inclusion. Yet, if not carefully managed, digital credit also runs the risk of excluding, over-charging, and over-extending customers.

Seven years since the first digital credit product launched, the market in Kenya has grown exponentially and hosts a diverse ecosystem with more than 50 supply-side actors. The phenomenal expansion of digital credit in Kenya serves as a test-bed for the product and offers lessons for digital credit suppliers and regulators around the world.

SPTF and the <a href="/about/what-we-do/the-smart-campaign">Smart Campaign</a> commissioned MicroSave Consulting (MSC) to study the dynamics of the digital credit sector on both demand and supply sides. The output of the study was a comprehensive report on the current state of digital credit in Kenya. It looked at the evolving challenges in digital credit and made recommendations for a more responsible and customer-centric delivery of the product.

With participation from Smart Campaign Senior Director <a href="/bio/alexandra-rizzi">Alexandra Rizzi</a>, this webinar will:
<ul>
 	<li>Help participants understand the digital credit landscape in Kenya</li>
 	<li>Assess the progress and challenges around making digital credit responsible and inclusive</li>
 	<li>Recommend steps towards a more responsible delivery of digital credit</li>
</ul>
We hope you can join us!

<img class="alignnone size-large wp-image-36766" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2019/09/MSC_Webinar-1-1024x683.jpg" alt="Infographic describing webinar schedule" width="1024" height="683" />

Webinar: Making Digital Credit Truly Responsible

Partnerships

Telcos

Event

Bansal, the <a href="https://www.centerforfinancialinclusion.org/about/what-we-do/the-smart-campaign">Smart Campaign</a>'s Senior Director in South and Southeast Asia, notes that the problem over-indebtedness is more severe in the island country than elsewhere.

She also points out that the government's decision to write off business loans of up to 100,000 rupees falls short.

"One-off measures will not do, says Ms Bansal: Sri Lanka needs properly enforced rules that prevent over-indebtedness and ensure fair treatment of borrowers."

<strong>Read the <a href="https://www.economist.com/finance-and-economics/2019/08/15/microfinance-is-driving-many-sri-lankan-borrowers-to-despair">full article</a> (soft paywall).</strong>

In The Economist: Hema Bansal on Over-Indebtedness in Sri Lanka

South Asia

Sri Lanka

News

The term “rural brain drain” was popularized nearly a decade ago when two sociologists published a book documenting <a href="https://www.wired.com/2010/02/how-do-we-stop-hollowing-out-the-middle-of-america/">their experience living in Iowa</a>. Their goal was to understand the exodus of a young, educated workforce from rural areas to urban hubs. Today there are many factors contributing to this population shift, among them deindustrialization, lack of high-paying jobs, and weak broadband connectivity. A <a href="https://www.federalreserve.gov/publications/files/consumer-community-context-201901.pdf?mod=article_inline">Federal Reserve</a> report published earlier this year brought to light another reason for this phenomenon that dozens of states are grappling with: student loan debt.

The student debt crisis made headlines in 2010 when student loan debt surpassed credit card debt in the United States, at a staggering $1.56 trillion today, student debt is growing much faster than <a href="https://www.finder.com/student-loans-to-overtake-mortgages">mortgage debt</a> (10.4 percent per year versus 0.6 percent for mortgages). According to the Federal Reserve Bank of New York, nearly two-thirds of this financial burden falls on Americans under the age of 39.

As young people are increasingly burdened by student debt, they are flocking to the places that offer high-paying jobs: cities. According to Pew Research, <a href="https://www.pewresearch.org/fact-tank/2018/03/16/how-millennials-compare-with-their-grandparents/">88 percent</a> of millennials live in metropolitan areas. The average age is higher in <a href="https://www.citylab.com/life/2018/05/mapping-americas-aging-population/561200/">the Midwest and the Appalachians</a>, regions that are struggling to keep pace with urban hubs in terms of broadband access, variety of jobs, quality of higher education institutions, and other success factors in today’s markets. As evidenced by the Fed’s report, individuals with student debt are less likely to remain in rural areas than those without debt. Furthermore, nearly two-thirds of the students most burdened by debt leave rural areas within one year after entering repayment. The term for this migration pattern has been coined the “rural brain drain,” and its impacts on the economic vitality of these regions are increasingly apparent. The inability of rural areas to attract a young, educated workforce is deepening the rural-urban divide.
<blockquote>Young people are flocking to the places that offer high-paying jobs: cities.</blockquote>
Some may argue that widespread access to education loans has created better opportunities for younger populations all over. However, according to U.S. Census data, wages have been stagnant since the 1970s, while the average cost of public college tuition has increased almost four fold. Simultaneously, homeownership among those under 35 has dropped <a href="https://www.census.gov/library/stories/2018/08/homeownership-by-age.html">10 percent</a> since 2006, and birth rates have declined every year since 2007. People in the age groups we might expect to be buying homes, settling down, and raising the next generation cannot afford to do so.
<blockquote>Wages have been stagnant since the 1970s, while the average cost of public college tuition has increased almost four fold.</blockquote>
We often look to countries like Finland, Denmark, and Norway, which offer tuition-free college to their citizens, as paradigms of what could exist here at home. Which country has the best model for us to try to replicate? According to former Secretary of Labor Robert Reich, the answer is <a href="http://inequalityforall.com/wp-content/uploads/2014/12/A_Visual_StoryPDF.pdf">the United States</a>. In post-war America, tuition fees were waved for veterans, and there was a massive proliferation of public universities. The GI Bill was one of the important factors that led to a tripling of the number of Americans with a bachelor’s degree from 1950 to 1977, and these educated workers helped the U.S. to grow to have the largest and most prosperous middle class in the world. At this time, public tuition was about 6 percent of an average male salary, compared to today’s 25 percent.

Times have changed, however, and modern problems require modern solutions. Refinancing and forbearance can provide some relief, but they ultimately increase debt in the form of interest. Other <a href="https://www.forbes.com/sites/andrewjosuweit/2017/11/05/6-ways-congress-can-help-ease-the-student-loan-crisis/#1cdcbb656cf6">proposals</a> to remedy the student debt crisis include erasing all debts, boosting the tax deduction for those making on-time payments, expanding the Pell grant program, creating a tiered system that lowers or eliminates debt based on income, and proper adherence to the <a href="https://www.nerdwallet.com/blog/loans/student-loans/public-service-loan-forgiveness/">Public Service Loan Forgiveness Program</a>. The latter program was created in 2007 to forgive remaining student loan balances of those who have worked for 10 years in public service. In 2017 applicants first became eligible for relief through this program, which has a two-year budget of $700 million. However, as of April this year, only 1.5 percent of those funds have been utilized. While the <a href="https://studentaid.ed.gov/sa/repay-loans/forgiveness-cancellation/public-service/temporary-expanded-public-service-loan-forgiveness#how-qualify">requirements</a> for forgiveness are publicly available, the Department of Education has come under fire for not providing clear guidance to successfully navigate them.

Some believe that a policy to eliminate all or most student debt would be a major <a href="https://www.marketwatch.com/story/canceling-14-trillion-in-student-debt-could-have-major-benefits-for-the-economy-2018-02-07">economic stimulus</a>, spurring job creation and narrowing the wealth gap over the next decade. Our recent history proves that a well-educated population fuels a virtuous cycle of growth through competitive wages, increased tax revenues, and expansion of jobs. An affordable education lies at the foundation of this cycle, and will be a key factor in creating a more economically inclusive rural and urban America.

Rural America: Another Casualty of Student Loan Debt?

North America

United States

Discussions about digital credit default rates have critiqued the "how" it gets delivered, but an alternative view is to blame "what" is being offered and conclude that more diverse and useful DFS are needed sooner. The digital credit so far in the form of the uniform, very small amount nanoloans aren’t delivering a strong enough value proposition in meeting specific needs to rank them high in a person’s order of expenses to cover and debts to repay.

How do we know that improving value propositions of DFS hold promise as a solution to defaults? Looking to two markets whose mobile money ecosystems have had more time to develop credit products can provide clues.

In this post, I'll compare digital credit in Kenya and Tanzania. CGAP’s research reveals <a href="https://www.cgap.org/sites/default/files/publications/Working-Paper-A-Digital-Credit-Revolution-Oct-2018.pdf">Tanzania’s default rate is 31 percent, almost 3 times higher than Kenya’s</a>. Why do these neighbors have such drastically different default rates? Apart from other <a href="https://fsdkenya.org/blog/four-differences-and-five-similarities-of-digital-credit-markets-in-kenya-and-tanzania/">distinctions</a>, two differences embedded in the research are:
<ul>
 	<li>Kenya has diversified the range and number of products on the market.</li>
 	<li>Tanzanians consistently preferred to use informal sources rather than digital credit.</li>
</ul>
Compare the data from the graphs below, from "<a href="https://www.cgap.org/sites/default/files/publications/Working-Paper-A-Digital-Credit-Revolution-Oct-2018.pdf">A Digital Credit Revolution: Insights from Borrowers in Kenya and Tanzania</a>," a CGAP/FSD working paper published October 2018.

Diversifying Digital Financial Services: A Way to Tackle Defaults and Over-Indebtedness

Tanzania

Informal Credit

Join <a href="/about/what-we-do/the-smart-campaign/">Smart Campaign</a> Director <a href="/bio/isabelle-barres">Isabelle Barrès</a> at <a href="https://registration.european-microfinance-week.eu/ehome/emw2018/758265/">European Microfinance Week</a> in Luxembourg November 14-16, 2018. Organized by the European Microfinance Platform (e-MPF), the conference will welcome more than 500 professionals to discuss multiple aspects of financial inclusion.

<strong>Thursday, November 15th, 11am-12:30pm</strong>
Isabelle will be presenting findings from the Smart Campaign’s research with members of the Fintech Protects Community of Practice in a session entitled, “Client Protection and Digital Finance, Practices from Kenya.”

<strong>Friday, November 16th, 11am-12:30pm</strong>
Isabelle will participate in a panel discussion, “Preventing Overindebtedness in Cambodia: Can Self-Regulation Work?”

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European Microfinance Week 2018

Alexandra Rizzi

Senior Director, Smart Campaign 

Isabelle Barrès

Vice President and Campaign Director, Smart Campaign

Mayada El-Zoghbi

Managing Director

Alex Taylor

Allyse McGrath

Anita Gardeva

Carmen Paraison

Chris Wolff

Claudio Storm

Danielle Piskadlo

Elisabeth Rhyne

Hema Bansal

Jeffrey Riecke

John Owens

Kai Hsu

Rachel Morpeth

Sergio Guzmán

Tanwi Kumari

Bangladesh

Belgium

Benin

Chile

Europe and Central Asia

Georgia

Ghana

Greece

India

Latin America and The Caribbean

Pakistan

Peru

Philippines

Russian Federation

South Africa

Sudan

Taiwan, China

Uganda

Agent Banking

Alternative Data

Appropriate Product Design and Delivery

Banks

Behavioral Insights

Consumer Credit

Credit/Debit Cards

Crowdfunding

Data Analytics

Education Finance

Financial Capability

Financial Health

Financial Technology

Fraud

Governance

Impact Investing

Insurance

Microfinance

Microfinance Institutions

Mobile Banking

Payday Loans

Privacy

Responsible Investing

Risk Management

Saving

Social Performance

Trends

Underwriting

Youth

The majority of Kenyans have mobile money accounts; their activity demonstrates digital financial services’ potential. Accion helps Kenyan innovators harness emerging technologies to create new financial services.

India is a global leader in financial inclusion. For over a decade, Accion has worked with and learned from India’s innovators, investors, and policymakers to expand economic opportunity for its people and businesses.

India is one of the fastest growing and complex markets for inclusive finance, where there is a huge opportunity to extend financial services to the underserved. Yet the country has struggled in the past with unbridled growth of the microfinance sector leading to a crisis in debt stress, notably in <a href="https://www.huffingtonpost.com/elisabeth-rhyne/on-microfinance-whos-to-b_b_777911.html">Andhra Pradesh</a> in 2010.

Policymakers and networks of microfinance institutions actively responded to these crises and elevated consumer protection on the policy agenda. But it’s one thing for regulators to signal policy support for consumer protection. It’s quite another to tackle the nuts and bolts of implementing best practices, especially in such a complex market as India.

[caption id="attachment_33139" align="alignleft" width="500"]<img class="wp-image-33139" src="https://content.centerforfinancialinclusion.org/wp-content/uploads/sites/2/2018/10/Sa-Dhan-tool-launch-photo-1024x714.jpg" alt="announcement-of-sadhan-monitoring-tool-group-photo" width="500" height="349" /> The Sa-Dhan monitoring tool was announced at a launch event during the Sa-Dhan Annual Conference in New Delhi in September 2018.[/caption]

One of the scalable solutions to arise in India is the concept of microfinance networks as Self-Regulatory Organizations (SROs). Networks that have been designated by the Reserve Bank of India (RBI) as SRO networks are responsible for monitoring compliance of member MFIs to the microfinance industry code of conduct and providing an effective grievance redressal mechanism between borrowers and member institutions. <a href="http://www.sa-dhan.net/">Sa-Dhan</a>, the largest organization of community banks in India, was designated an SRO in 2015. While Sa-Dhan had previously filled a quasi-regulatory role, this official designation expanded its mandate for monitoring and enforcement, in turn expanding its need for tools to identify and respond to risks at both the market and institution levels.

Aiming to make a country-wide impact on the state of consumer protection in India, CFI’s <a href="https://www.smartcampaign.org/">Smart Campaign</a> and Accion’s Global Advisory Services collaborated with Sa-Dhan to build a digital monitoring tool based on the Smart Campaign’s <a href="https://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles">global standards for financial consumer protection</a> and local regulatory guidelines. The tool is to be the vehicle through which Sa-Dhan collects the information it needs from its members to fulfill its supervisory role in monitoring compliance with the code of conduct. Accion’s advisory team led the digitization of the tool, building of the data warehouse, and the corresponding web platform. The tool was officially launched at Sa-Dhan’s annual conference with technical and financial support from the International Finance Corporation. Sa-Dhan’s members can now efficiently self-report data through the tool’s online interface and Sa-Dhan can quantitatively assess market dynamics, especially areas of over-indebtedness risk.
<blockquote>The tool is to be the vehicle through which Sa-Dhan collects the information it needs from its members to fulfill its supervisory role in monitoring compliance with the code of conduct.</blockquote>
This new monitoring mechanism will help to instill consumer protection in Sa-Dhan’s nearly 200 member MFIs and protect more than 30 million clients in India.

Across the microfinance sector new examples of “regtech” and “suptech” are emerging. Just as technological transformation of MFIs can scale their services to new clients, technology can help regulatory bodies meet their broadened responsibilities to oversee the proliferation of lenders. P. Satish, Executive Director of Sa-Dhan sees the new tool as an essential component to meeting its SRO mandate through technology that will “help member MFIs with their data analytics and compliance measures, as well as reduce potential client distress.”

After the initial rollout and training workshops for MFIs across the country, Sa-Dhan will put the tool into practice and will use the reports in consultation with the RBI to identify “hot spots” of overindebtedness or lack of compliance to the code of conduct. These reports will also help Sa-Dhan identify under-penetrated areas and help lenders to expand services.

India’s experimentation with self-regulation holds lessons for the world. Traditionally, self-regulation models have been met with skepticism, especially regarding how non-government networks can monitor and enforce compliance among members. The collaboration between the RBI and SROs in India give weight to the microfinance networks through a layered regulatory approach, and technology advances can build capacity of networks like Sa-Dhan to access data from their members and oversee performance.

The Sa-Dhan monitoring tool can serve as a model for expanding consumer protection in other markets, especially those where there are concerns of rising debt stress. Better monitoring tools can serve as an early warning system and help provider networks or regulators head off crises before they spread.

A New Digital Monitoring Tool in India Could Boost Consumer Protection Capacity

This conference provides a unique platform for dialogue, deliberation, information sharing and forging partnerships. It aims to provide stakeholders with a platform to deliberate on specific sectoral concerns and challenges in the implementation of India’s Financial Inclusion program. The theme of this year's National Conference is "Propelling the Growth of the Informal Sector Through Microfinance."

The Smart Campaign is attending the Sa-Dhan Annual Conference in New Delhi, India to unveil a new client protection tool developed in partnership with the Sa-Dhan association of community development financial institutions. This new tool will allow the association to monitor its members to ensure compliance with its Code of Conduct, as well as collect information about over-indebtedness risks for clients at member institutions. Tanwi Kumari and Hema Bansal of The Smart Campaign will be speaking at the event.

Sa-Dhan National Conference

As digital credit providers have grown exponentially over the past few years, and as digital products and models have proliferated, so too have concerns around consumer protection. In the recently published report, <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/1036-responsible-digital-credit">Responsible Digital Credit</a>, I argue that ensuring that digital credit customers receive responsible treatment requires more than enhanced consumer protection laws and regulations. It also requires strong commitment from the digital credit industry. Finally, it needs consumers who are empowered to play a more proactive role in managing their digital credit responsibly.

Over the past year, I have interviewed digital credit industry associations, credit providers and their third-party data analytic providers, regulators, policy makers, and various consumer protection leaders. Many of these groups are working to develop responsible digital lending principles. With their input, my report proposes a guiding framework for responsible digital lending.  The framework uses the Smart Campaign <a href="https://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles">Client Protection Principles</a> as a basis for grouping the issues. In addition, I propose an eighth principle: security and fraud protection.

Digital credit, and especially the use of mobile phones, significantly alters interactions between borrowers and lenders. Lenders utilizing the mobile channel to advertise, acquire and transact with customers must pay particular attention to the limitations of mobile interaction with customers and follow industry <a href="http://onlinelendersalliance.org/wp-content/uploads/2016/03/Best-Practices-2016-1.pdf">mobile best practices</a>. While many of the standard consumer protection practices continue to apply, new concerns, or more accurately, new faces on older concerns, have emerged. In this post, I want to highlight several of the considerations I found most important and relevant for the digital lending industry.
<h2><strong>Responsible Algorithms</strong></h2>
Many digital credit models rely on algorithms to process data about clients and make credit decisions. Because most lenders consider their algorithms proprietary, it is difficult for observers to know on what basis credit decisions are actually made. This opaque situation raises the spectre of discrimination. Attributes that are considered inappropriate bases for differentiation, such as religion, language, gender, or ethnic origin, are areas of particular concern with regard to algorithm-based lending practices. As highlighted by a Smart Campaign <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/916-smart-brief-tiny-loans-big-questions">report</a>, while credit offers may differ based on risk analysis, such differentiation should be consistently applied, stated in advance, and made with the goal of benefitting clients. To prevent discriminatory digital credit practices, some recommendations include:
<ul>
 	<li><a href="https://www.whitecase.com/publications/insight/algorithms-and-bias-what-lenders-need-know"><strong>Pretest, test and retest for potential bias</strong></a><strong>.</strong> Digital credit providers and third-party data analytics providers should continuously monitor the outcomes of their algorithmic programs to identify potential problems. Such testing could involve running scenarios to identify unwanted outcomes and developing and building controls that prevent adverse outcomes.</li>
 	<li><a href="http://www.ijmo.org/papers/43-A10212.pdf"><strong>Document the rationale for algorithmic features</strong></a><strong>.</strong> Digital credit providers should be able to provide visualization and a decision tree for the factors their algorithms analyze, as well as the justification for relying on these factors. The rationale should address how borrower debt capacity is assessed, given the importance of this concept in traditional underwriting.</li>
 	<li><strong>Independent review</strong> of companies' proposed data sets and/or algorithms.</li>
</ul>
A self-regulatory approach could be used to develop best practices guidelines for data inputs and the development of nondiscriminatory artificial intelligence systems, following the model that has been successful for the Payment Card Industry Security Standards Council.
<h2><strong>Indebtedness Monitoring</strong></h2>
Because digital lending is often based on non-traditional underwriting criteria, to prevent over-indebtedness among digital borrowers it may be relatively more important to monitor outcomes at the portfolio level. Some of the ways to do this include:
<ul>
 	<li><strong>Avoidance of debt traps</strong> by ensuring that clients are not forced into automated repeat loans.</li>
 	<li><strong><a href="http://www.responsiblebusinesslending.org/">Responsible credit reporting</a></strong> – Better compliance with reporting strengthens markets and leads to better client protection practices.</li>
 	<li><strong><a href="http://www.centerforfinancialinclusion.org/storage/documents/Smart_Brief_Tiny_Loans_Big_Questions_Final_092617.pdf">Monitoring digital credit provider’s portfolio quality</a></strong> – Industry benchmarks for portfolio quality can help to advance the understanding of risks and avoid business models that rely for their success on high default rates.</li>
</ul>
<h2><strong>Digital Transparency </strong></h2>
Digital credit platforms allow for 24/7 communications with clients that, if harnessed properly, can assist them with immediate technical support, remind them about upcoming payments and even identify counselors or resources for clients in financial stress. However, when communication is totally digital, there are heightened concerns about ensuring that clients really know what they are signing up for. Disclosure must lead to client understanding. Borrower disclosure standards should address:
<ul>
 	<li>Standards for <strong>honest advertising</strong> and penalties for misleading marketing materials of credit products. Furthermore, providers should advertise the name of the financial regulator they report to in all advertising materials.</li>
 	<li><strong>Readability</strong> and format – Disclosures need to be easy to comprehend, available in the customer’s local language, and provided in print and digital formats.</li>
 	<li><strong>Comparative tools</strong> – Standard summary disclosure documents would allow borrowers to compare credit offers, both digital and traditional.</li>
 	<li><strong>Adequate notice periods</strong> – Consumers should be notified in advance of changes to interest rates, fees or terms and conditions.</li>
</ul>
A somewhat different but related and relevant concern, often overlooked in this context, is the vulnerability of individual investors who put their money into pure peer-to-peer (P2P) lending platforms. Protections need to be extended to them as well, with a focus on ensuring that they receive the information they need to evaluate risks and that they have recourse channels when something goes amiss.
<h2><strong>Data Privacy and Usage Standards</strong></h2>
While many regulators and most industry groups agree that it is important to protect the confidentiality and security of customers’ information, data use and the level of disclosure about its use are challenging topics. In the <a href="http://ec.europa.eu/justice/data-protection/reform/index_en.htm">EU</a> and in countries such as <a href="https://www.pc.gov.au/inquiries/completed/data-access/thedraft">Australia</a>, regulators are enacting rules mandating that individuals be notified about the use of their personal data and allowed to opt out. Opt-out rules should be considered as a potential requirement for all digital credit providers, especially in markets where mobile push-marketing has become problematic.

Over the next several years it will be important for laws or regulations to be put in place to protect consumer data privacy and guide information sharing. The rules need to:
<ul>
 	<li>Provide for informed consent, such that customers explicitly permit electronic data collection prior to its collection and use, and are given the option to consent or not.</li>
 	<li>Require providers to have a clear data collection and handling policy which limits the amount of data collected as well as the timeframe it is stored.</li>
 	<li>Inform clients about their data trails and credit histories, including the ability to ensure accuracy and correct for any errors or discrepancies.</li>
 	<li>Give regulators the power to discipline providers who repeatedly allow personal data to be misused.</li>
</ul>
<h2><strong>Fraud Prevention and Security </strong></h2>
New security vulnerabilities arising from digital credit strongly point to fraud and cyber-security as consumer protection concerns. It is increasingly urgent for digital credit providers to adopt standard security compliance measures and then to regularly test and update them. Providers must also be responsible for ensuring that the third-parties they use, including lead generators, brokers, agents, and data analytics providers, also have adequate security in place. Ultimately, providers need to be responsible for the actions of their third-parties (e.g., agents, contractors, lead generators, brokers and collectors).

Consumers should be made aware of the potential for fraud and encouraged to report suspected fraud cases or security breaches. Consumer awareness campaigns on the most common incidents of fraud (via the internet, SMS alerts, signage at agent kiosks, etc.) can help with this.

While the recommendations just listed do not apply in all markets, they do point to the urgent need for regulators, industry bodies, individual providers and consumers to work together to construct the ground rules for responsible digital credit that will ensure that consumers are adequately protected.

<em>Editor's Note: This research was made possible by support from Mastercard Foundation and other partners.</em>

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A Framework for Responsible Digital Credit

CFI Research Fellows Program

<span style="float: none;background-color: transparent;color: #333333;cursor: text;font-family: Georgia,'Times New Roman','Bitstream Charter',Times,serif;font-size: 16px;font-style: normal;font-variant: normal;font-weight: 400;letter-spacing: normal;text-align: left;text-decoration: none;text-indent: 0px">Despite the rise in mobile money in Africa, and globally, the gap between supply and demand for credit in the region remains. Surprisingly, in this milieu, start-ups are at risk of accelerating the pace of over-indebtedness in Africa. The number of start-ups reaching last mile clients is rising. The driver of this is fintechs taking advantage of a business opportunity, and the prospect that if you offer clients much-needed credit at a lower cost than the alternative, they will be better off.</span>

But is this necessarily true? Are these start-ups offering solutions to the credit needs that many small and medium African businesses have, and are clients better off with these solutions? Or is the fintech digital credit hype attracting lenders that offer credit in the wrong places – and for the wrong reasons? What is needed to ensure that digital credit is provided responsibly, for the benefit of clients?
<h4><strong>Start-ups are at risk of accelerating over-indebtedness by supplying credit to clients without conducting appropriate repayment capacity analysis.</strong></h4>
Some estimate that digital technologies have cut the cost of providing financial services by 80-90 percent (<a href="http://appgfintech.org.uk/wp-content/uploads/2016/11/MG-Digital-Finance-For-All-Full-report-September-2016.pdf">McKinsey Global Institute, 2016, PDF</a>). Africa is taking the lead in the rise of mobile technology, and the opportunities are promising. Start-ups in this space are making big strides. Those involved in digital credit either deliver digital credit directly or enable its delivery through downstream product servicing. The number of fintechs – startups offering these services – in Africa is growing daily (<a href="http://fintechranking.com/2016/12/15/63-companies-shaping-africas-fintech-ecosystem/">Mesropyan, 2016</a>).

Technology well used offers opportunities not previously available. However, two key issues need to be recognized and addressed in order to generate long-term benefits for both clients and providers.
<ol>
 	<li>Provider and client interests must be aligned. If providers profit while clients are experiencing stress in repaying, defaults will catch up with the client or the institution, and the client will no longer be able to borrow. Aligning interests requires providers to think of client benefits as well as their own, from the start.</li>
 	<li>A well-designed loan should match the ability to repay. Well-designed loans are a blessing, for example, helping a small business; yet loans that do not consider clients’ capacity to repay sets them up for failure. Even if they repay in the short term – which is often why default rates stay low – it can be at the cost of extreme hardship, making it a poor predictor of over-indebtedness. It may take some time before the debt stress of clients affects providers.</li>
</ol>
<h3><strong>"Instant": an Opportunity and a Risk for Consumers</strong></h3>
A key attribute digital lenders advertise is speed of access. Where traditional loans could take weeks for approval, with many requirements, this is a plus from the perspective of clients. But the automation and speed raises concerns: are decisions made too quickly, and are risks adequately measured and mitigated, especially from the clients' perspective?

Other aspects of digital credit lead to <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/916-smart-brief-tiny-loans-big-questions">new risks</a> compared with analog lending: start-to-finish digitization; the move from high to low touch processes; small credit amounts that grow; short-term loans; reliance on alternative data analytics; and decentralized support workforces.
<h3><strong>What Could Go Wrong?</strong></h3>
With analog credit, prevention of over-indebtedness centered on adequate repayment capacity, and on growth not taking place at the expense of quality.

In the digital context, the following major categories of risk have been identified (Center for Financial Inclusion, 2017/2018. See References):
<ul>
 	<li>Limited – if any – debt capacity analysis</li>
 	<li>Products that do not match client needs</li>
 	<li>Lack of credit reporting</li>
 	<li>Automatic renewals</li>
 	<li>Aggressive sales and marketing</li>
 	<li>Disproportionate consequences of late payments that lead to a cycle of debt.</li>
</ul>
<h4><strong>Algorithms are institution centric, not client centric. Over-indebtedness is not only reflected in default, it is first reflected by the extent of the sacrifices that the client endures to avoid defaulting.</strong></h4>
Alternative credit scoring methods – often using elaborate algorithms that predict the probability of repayment – help to include people who have thin credit files and who would otherwise have been excluded. However, these models are a poor replacement for the repayment capacity analysis previously conducted by lenders serving vulnerable excluded populations. While the algorithm may predict whether or not an institution will be repaid, it does not consider clients' situations and needs, and therefore, the sacrifices that clients might have to make in order to repay. Over-indebtedness is not only reflected in default, it is first reflected by the extent of the sacrifices that the client endures to avoid defaulting. Algorithms are institution centric, not client centric. They are meant to learn over time, becoming refined and better predictors; yet they do so at the expense of early clients who enabled the algorithm to become better fine-tuned, as they have a higher probability of defaulting and suffer dire consequences (<a href="https://www.businessdailyafrica.com/economy/Pain-of-Kenyans-blacklisted-for-amounts-as-small-as-Sh100/3946234-3374120-r0r2bfz/index.html">Ngigi, 2016</a>).

The promise of well-tuned algorithms saving costs and managing institutional risk is unfortunately skewing attention away from client risks. Over-indebtedness needs to be reframed from a client perspective: can clients afford the loan? Even if they can repay, what sacrifices are they making? Are they at risk of not being a client ever again in the future (which would hurt both the client and the provider)?
<h3><strong>Mitigating Over-Indebtedness in a Digital World</strong></h3>
Over-indebtedness is a multi-stakeholder issue, and is linked to the client protection issues summarized in the <a href="https://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles">Client Protection Principles</a>. Prevention of over-indebtedness is a particularly tricky one, in that it requires the concerted effort of a wide range of stakeholders.

Providers have a responsibility to ensure that their practices do not lead to an oversupply of credit to clients who are unable to meet their payment obligations, and digital lenders will need to adopt a more client-centric approach to understand the risks of over-indebtedness from a client perspective. Algorithms need to evolve to take this into account.

Digital lenders need to understand the risks of over-indebtedness from a client perspective, and algorithms need to evolve to take this into account. Regulation also must guide good practice for fintech digital lenders<strong>.</strong>

Because only one irresponsible lender is needed in terms of over-indebtedness to negatively affect clients, it is necessary that financial consumer protection regulation evolves to guide the practices of otherwise unscrupulous digital lenders.

Investors can, and should, use their leverage to encourage good practices by digital lenders, as they have for analog lenders. They can reward digital lenders who design and deliver appropriate products, are transparent about terms and conditions, explain to clients the risks of over-indebtedness, adopt fair and responsible practices during repayments, and help clients who cannot, but want to, repay.

Importantly, digital providers can leverage the same technology used to deliver products to educate and empower clients. Clients have rights and responsibilities. Informed consumers are better able to protect themselves and avoid becoming victims of predatory lenders.
<h3><strong>Over-Indebtedness Is Multidimensional and Dynamic</strong></h3>
In the interest of long-term mutual benefits for both providers and clients, providers need to move away from a uni-dimensional definition of over-indebtedness that overly emphasizes repayment as the proxy for whether or not a client is indebted, towards <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/201-over-indebtedness-of-microborrowers-in-ghana-an-empirical-study-from-a-customer-protection-perspective">client-focused definitions of over-indebtedness</a>.

Digital credit providers need to complement credit bureau data with disbursement and repayment data on digital loans so that a fuller financial picture can emerge for digital borrowers.

Over-indebtedness is not a steady state. As the lives of vulnerable clients evolve, so do their needs and challenges. A client who may have received a loan from a responsible lender in the past may suddenly not be in a position to repay. We need to develop ways to monitor whether clients are showing signs of financial stress. Responsible institutions should be able to identify this, and work with clients until it is resolved.

The role of responsible providers goes beyond providing loans to ensuring that clients are supported, if needed. <a href="https://www.microfinanceopportunities.org/">Microfinance Opportunities</a>, in collaboration with <a href="http://socialperformance.net/">Social Performance Solutions</a>, has been developing a stress assessment tool that enables providers to monitor whether borrowers are incurring stress after having received a loan. Such tools are extremely important to have a full picture of over-indebtedness, and a broader suite of tools needs to be available to responsible providers.
<h3><strong>Fintech Protects Against Over-Indebtedness</strong></h3>
Fintech digital credit providers need to unite and agree to collective measures to tackle the problem of over-indebtedness. This will entail defining responsible digital underwriting, leveraging technology, while learning from the past, expanding credit bureau reporting, and agreeing on common practices for the benefit of clients. Some fintechs are already taking the lead, and through the Smart Campaign’s <a href="http://www.smartcampaign.org/about/fintech-protects-community-of-practice">Fintech Protects Community of Practice</a>, they are working together to define and implement responsible practice. The body of evidence around risks is growing. Now is the time to define the guidelines of good practice for fintech digital lenders and identify solutions that work for clients.

<strong>References</strong>

McKinsey Global Institute, “<a href="http://appgfintech.org.uk/wp-content/uploads/2016/11/MG-Digital-Finance-For-All-Full-report-September-2016.pdf">Digital Finance for All: Powering Inclusive Growth in Emerging Economies</a>,” September 2016.

Elena Mesropyan, “<a href="http://fintechranking.com/2016/12/15/63-companies-shaping-africas-fintech-ecosystem/">63 Companies Shaping Africa’s FinTech Ecosystem</a>,” Fintech Ranking, December 2016.

Alexandra Rizzi, Isabelle Barrès, Elisabeth Rhyne, “<a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/916-smart-brief-tiny-loans-big-questions">Tiny Loans, Big Questions</a>,” Center for Financial Inclusion at Accion.

John Owens, “<a href="http://www.centerforfinancialinclusion.org/programs-a-projects/cfi-fellows-program/783">Responsible Digital Credit</a>,” Center for Financial Inclusion at Accion. Forthcoming, 2018.

George Ngigi, “<a href="https://www.businessdailyafrica.com/economy/Pain-of-Kenyans-blacklisted-for-amounts-as-small-as-Sh100/3946234-3374120-r0r2bfz/index.html">Pain of Kenyans Blacklisted for Amounts as Small Sh100</a>,” <em>Business Daily Africa</em>, September 2016.

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Start-Ups and Digital Innovation: Are Fintechs in Africa Over-Indebting their Customers?

Very small instant consumer loans have ballooned from 11 deployments in 2011, to 52 in 2016, with a particular concentration in East Africa. In just a few years, through models such as M-Shwari, M-Pawa, Tala and Airtel Money, tens of millions of people have borrowed tiny amounts over their phones. These services represent an enormous increase in formal financial inclusion. They address a fundamental consumer need previously unavailable to lower income people from the formal financial system: the need for very short term money management tools to cope with income and expense volatility. While they are in many ways a boon, they also contain, and in some cases heighten, risks for their users.

This Brief enumerates and discusses emerging consumer risks posed by these products, using the Client Protection Principles as an organizing framework. We hope this lens will assist the mobile financial sector to articulate and build a consensus about responsible practices in mobile finance.

&nbsp;

Tiny Loans Big Questions: Client Protection in Mobile Consumer Credit

Mastercard Foundation

If you’re based in the United States, you’ve likely heard about how student loan debt is problematic and has been for years. The growing volume of student debt that has become more and more the norm is so high, its effects can be overwhelming. But how bad is it? Is it just a matter of students needing to hunker down (a little longer) and pay their dues (a little more)?

To give you a sense, between 2004 and 2014, there was a <a href="http://www.epi.org/publication/the-class-of-2017/">74 percent</a> increase in student loan balances, according to the Federal Reserve Bank of New York. Delinquency rates for student loans are <a href="https://www.nytimes.com/2017/05/20/opinion/sunday/student-debts-economy-loans.html?_r=0">higher</a> than those of home mortgages, car loans, or credit cards. And a 2015 survey of borrowers by the nonprofit American Student Assistance (ASA) found that <a href="http://www.asa.org/site/assets/files/4743/life_delayed_whitepaper_2015.pdf">one in five</a> respondents postponed marriage due to the hardship of student debt, and for the same reason over half of respondents delayed purchasing a home.

If you’re currently saddled with student loan debt, you might be agreeing that your massive loans affect your life, maybe even in more ways than you realize. If you don’t have student loan debt, you might be thinking that education is an investment, and this is the price that one has to pay to get its unique returns.

From where I sit, I think the student loan system is broken, and it’s hampering not only the financial health and lives of those with student loans, but the economy writ large. And I don’t think it has to be this way. This is a crisis that’s uniquely American.

In the United States, there are roughly 54 million millennials (one is <a href="https://en.wikipedia.org/wiki/Millennials">typically considered a millennial</a> if they were born during the time frame of the early 1980's to the mid 1990's or early 2000's) in the workforce, and about <a href="https://www.bostonglobe.com/lifestyle/real-estate/2016/09/30/student-loan-debt-causes-chain-reaction-housing-market/p6DGy4f2px9vadMJnKr39O/story.html">70 percent</a> of them have student loan debt. Between 2004 and 2014, the number of student loan borrowers increased by <a href="http://www.epi.org/publication/the-class-of-2017/">92 percent</a>, and, as already mentioned, the average student loan balance increased by 74 percent. As of 2013, roughly <a href="https://www.nytimes.com/2017/05/20/opinion/sunday/student-debts-economy-loans.html?_r=0">40 percent</a> of American households headed by someone younger than 40 years old had student loan debt, with this debt volume averaging nearly $30,000. While the cost of a four-year college education in the United States, when adjusted for inflation, is <a href="http://www.epi.org/publication/the-class-of-2017/">two and a half times higher</a> than it was in the 1978-79 school year, across this same time period, the inflation-adjusted median family income increased by only 20 percent.

In nominal terms, the volume of student loan debt in the United States is <a href="https://www.nytimes.com/2017/05/20/opinion/sunday/student-debts-economy-loans.html?_r=0">$1.3 trillion</a>, more than twice the total in 2008, and more than the current volume of car loan or credit card debt. The delinquency rate on student loans is higher than that of any other form of borrowing in the country, at roughly 10 percent. Of course such defaults can negatively affect future borrowing. And, to make matters worse, students <a href="https://www.bostonglobe.com/lifestyle/real-estate/2016/09/30/student-loan-debt-causes-chain-reaction-housing-market/p6DGy4f2px9vadMJnKr39O/story.html">increasingly</a> take out student loans and do not graduate from school.

We at CFI have <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/807-beyond-financial-inclusion-financial-health-as-a-global-framework">recently shared research</a> on the concept of financial health. Financial health is a relatively new term in the financial inclusion community, and it assesses how well one’s daily financial systems enable a person or household to build resilience to shocks and pursue opportunities and dreams. In collaboration with the Center for Financial Services Innovation (CFSI) and Dalberg’s Design Impact Group (DIG), we carried out a <a href="http://www.centerforfinancialinclusion.org/storage/documents/FinHealthGlobal-FINAL.2017.04.11.pdf">year-long study</a> into how to adapt CFSI’s U.S.-based financial health framework to a developing country context. The study found that the concept of financial health can effectively be applied in many contexts, but specific contextual factors need to be accounted for.

We also applied this financial health research to a United States setting, which brings us back to the subject of student debt. We created a financial health assessment and <a href="https://cfi-blog.org/2017/06/14/accions-financial-health-results-of-a-survey/">disseminated it to Accion’s staff</a>. One of the big findings was that among Accion staff in their twenties, student loans are by far the dominant form of debt. Many of these individuals indicated that their student loan debt is a big and difficult issue for them to manage. Conversely, relatively few staff reported the same difficulties regarding their mortgages, and very few non-U.S. Accion staff reported holding student debt.

Beyond the negative effects of student loan debt on the borrower, evidence is mounting on the negative effects for the larger economy. Take the housing market in the United States, where homeownership is at a <a href="https://www.bostonglobe.com/lifestyle/real-estate/2016/09/30/student-loan-debt-causes-chain-reaction-housing-market/p6DGy4f2px9vadMJnKr39O/story.html">50-year low</a>. A survey from the National Association of Realtors and the ASA found that <a href="http://www.asa.org/site/assets/files/1777/nar_student_loan_debt_and_housing.pdf">71 percent</a> of student loan borrowers who didn’t own a home indicated that their student loans were the main prohibitive factor. More than half of these non-homeowner borrowers estimated that student loans would push their purchasing a home back by at least five years. In 2013, one in five student loan borrowers paid <a href="http://www.jchs.harvard.edu/sites/jchs.harvard.edu/files/lew_research_brief_student_loan_11_2015.pdf">14 percent or more</a> of their income on their student loan payments. This debt, especially if coupled with auto loans or credit card debt, leaves less room for both borrowers and lenders to qualify for or feel comfortable with the additional obligation of a mortgage.

A study by Fannie Mae found that, in general, college-educated Americans are <a href="https://www.bostonglobe.com/lifestyle/real-estate/2016/09/30/student-loan-debt-causes-chain-reaction-housing-market/p6DGy4f2px9vadMJnKr39O/story.html">27 percent more likely</a> to own a home than those who are high school-educated; however, those with student loan debt who fail to graduate are 37 percent less likely to own a home than those who simply graduated from high school.

Citing the Harvard Joint Center, Jon Gorey of <em>The Boston Globe</em> <a href="https://www.bostonglobe.com/lifestyle/real-estate/2016/09/30/student-loan-debt-causes-chain-reaction-housing-market/p6DGy4f2px9vadMJnKr39O/story.html">outlines</a> how first-time buyers cause a chain reaction in the economy, affecting the broader housing market as well as related industries like home appliances. When there are fewer first-time home buyers, it makes it more difficult for homeowners to trade-up.

So, what’s the solution?

There are many angles of attack that could help, starting with wages. A recent piece by <em>The New York Times</em> <a href="https://www.nytimes.com/2017/05/20/opinion/sunday/student-debts-economy-loans.html?_r=0">cites</a> the potential for wage growth from: increasing collective bargaining power among white-collar and service-sector workers; making salaried workers more eligible for overtime pay; ending discriminatory pay practices; and making it tougher for U.S. companies to outsource overseas.

Perhaps the most obvious approach, as suggested by the average tuition figure cited above, would be lowering the cost of education. We saw encouraging steps taken in this direction just two weeks ago by the State of Michigan. The University of Michigan announced its “Go Blue Guarantee” program which provides qualifying students from families in Michigan with incomes below $65,000 a year with free tuition for up to four years. The program begins next January and reportedly will not result in the reduction of any need-based aid for students from families earning more than $65,000. In its <a href="http://ns.umich.edu/new/releases/24912-u-m-unveils-tuition-guarantee-for-michigan-students-with-need">news release</a> the University noted “tremendous credit also goes to our generous donors whose philanthropic commitment to financial aid underlies the financing of the 'Go Blue Guarantee.'"

Lastly, bolstering student loan borrowers’ money management skills is essential. Student borrowers are young and often inexperienced when they take on their debt commitments.

For more, including on good money management, learn about our financial health research <a href="http://www.centerforfinancialinclusion.org/publications-a-resources/browse-publications/807-beyond-financial-inclusion-financial-health-as-a-global-framework">here</a>, and take our survey to assess and better understand your own financial health <a href="https://www.surveymonkey.com/r/Q72Y2QQ">here</a>.

<strong>Have you read?</strong>

<a href="https://cfi-blog.org/2017/06/14/accions-financial-health-results-of-a-survey/">Accion's Financial Health - Results of a Survey</a>

<a href="https://cfi-blog.org/2017/05/23/explore-your-own-financial-health/">Explore Your Own Financial Health</a>

<a href="https://cfi-blog.org/2017/03/29/dollar-by-dollar-or-goat-by-goat-how-financial-health-translates-across-oceans/">Dollar by Dollar or Goat by Goat: How Financial Health Translates Across Oceans</a>

How Bad Is the U.S. Student Loan Debt Situation?

<em>&gt; Posted by Sonja Kelly, Director of Research, CFI</em>

In ethics, there is a commonly shared thought experiment called the trolley problem. You are standing next to trolley tracks, and a trolley is coming. In its current trajectory, it is going to run over five people who are tied to the tracks. You could divert the train using a lever in front of you, but then the trolley would hit one person tied to the tracks. Do you become active in this scenario and sacrifice the one person? Or do you abstain from involvement and watch the five people get run over?

<a href="https://commons.wikimedia.org/wiki/File:Trolley_problem.png"><img class="aligncenter wp-image-24127" style="border:0 solid #000000" src="https://centerforfinancialinclusionblog.files.wordpress.com/2017/09/trolly-problem.png" alt="" width="616" height="210" /></a>I don’t mean to be morbid here, but this is a thought experiment that I have been mulling over when it comes to financial inclusion.

Instead of people tied to tracks, I think of things that financial inclusion unlocks or restricts in the lives of individuals. If the world continues as is, and we don’t pull the “financial inclusion” lever, people are going to experience inequality of opportunity, financial illiteracy, a limited set of financial tools, and maybe even continued poverty—and that would be extraordinarily unfortunate. A world without financial inclusion would be an unequal and discouraging place from my perspective.

But as we enable financial inclusion, we must admit that there are also good things that we may be restricting and bad things that we may be unlocking.

People who relied previously on social capital and informal financial services might find that decoupling their finances from their relationships weakens those relationships, for example. Or they might find that they no longer have repayment structures that are flexible and forgiving. Or they might find that they are enrolled in services that aren’t suited to them, perhaps because of coercive sales practices or because they didn’t fully understand the services when they signed-up.

As more commercial players enter the financial inclusion space, we may see the sector’s social mission diluted and the unlocking of negative effects. If we pull the financial inclusion lever and strengthen and enable nontraditional providers, we risk misuse of sensitive data, overindebtedness, and other unintended consequences. The financial inclusion lever could, and probably will, be responsible for eroding social capital and disrupting economic equilibrium.

On balance, I think financial inclusion is an extraordinary source for good. I’ve been advocating for financial inclusion for the past decade and I wholeheartedly believe in its value in the lives of individuals. However, there are things that we sacrifice when we push for financial inclusion. Understanding what those things are—and the value that they hold in the lives of individuals—is critically important to being responsible as we advocate for inclusion. Of course mitigating and even eliminating those sacrifices are part of what the Smart Campaign and others working to ensure responsible treatment of clients in the financial inclusion sector are all about.

But even beyond the goal of being responsible, understanding what financial inclusion makes people give up may make our industry better at creating products that fit well into people’s lives.

<em>Image credit: <a href="https://commons.wikimedia.org/wiki/File:Trolley_problem.png">McGeddon via Wikimedia Commons</a></em>

<strong>Have you read?</strong>

<a href="https://cfi-blog.org/2017/07/05/offshore-financial-centers-for-financial-inclusion-an-aligned-industry-or-oceans-apart/">Offshore Financial Centers for Financial Inclusion: An Aligned Industry or Oceans Apart</a>

<a href="https://cfi-blog.org/2016/12/07/can-social-missions-be-preserved-in-initial-public-offerings/">Can Social Missions Be Preserved in Initial Public Offerings?
</a>

<a href="https://cfi-blog.org/2017/01/04/what-does-responsible-online-and-digital-credit-look-like/">What Does Responsible Online and Digital Credit Look Like?</a>

Some Thoughts on the Ethics of Financial Inclusion

<img class="alignright size-full wp-image-14372" src="https://centerforfinancialinclusionblog.files.wordpress.com/2014/03/logo.png" alt="" width="262" height="66" />On January 18<sup>th</sup>, 2017, the Consumer Financial Protection Bureau (CFPB) <a href="http://www.consumerfinance.gov/about-us/newsroom/cfpb-sues-nations-largest-student-loan-company-navient-failing-borrowers-every-stage-repayment/">filed suit</a> against Navient, the largest federal and private student loans servicer in the U.S., for “systemically and illegally failing borrowers at every stage of repayment.” Allegations include:
<ul>
 	<li>Misallocating student loan payments by failing to follow instructions from borrowers about how to apply their payments across their multiple loans.</li>
 	<li>Steering struggling borrowers toward multiple forbearances instead of lower payments via income-driven repayment plans. (Forbearance is an option that lets borrowers take a short break from making payments, but that still accrues interest.)</li>
 	<li>Providing unclear information about how to re-enroll in income-driven repayment plans.</li>
 	<li>Deceiving private student loan borrowers about requirements to release their co-signer (e.g. a parent or grandparent) from their loans, which can be advantageous given some lenders’ practices surrounding the death of a co-signer.</li>
 	<li>And failing to act when borrowers complained.</li>
</ul>
Navient currently services more than <a href="http://www.forbes.com/sites/zackfriedman/2017/01/20/navient/#612707b037c6">$300 billion in loans for more than 12 million borrowers</a>.

In a competitive workforce and a society that values higher education, students with a desire to advance themselves economically and professionally must borrow when they are unable to meet their education expenses with savings or current cash flows. In the U.S., student loans ballooned in 2016 to $<a href="https://www.wsj.com/articles/more-than-40-of-student-borrowers-arent-making-payments-1459971348">1.2 trillion</a>, with $56 billion in default.

One of the <a href="http://smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles">Client Protection Principles</a> promoted by the Smart Campaign is the prevention of over-indebtedness. In the developing countries where the Smart Campaign works, over-indebtedness can affect microfinance clients by causing them to work longer hours, reduce consumption, deplete savings, borrow to pay off current debt, sell assets, and deplete the assets of their relatives. Here in the United States, student borrowers may resort to many of the same strategies.

According to CFPB, Navient created obstacles to repayment by providing bad information, processing payments incorrectly, and ignoring borrowers’ complaints - illegally cheating many struggling borrowers out of their rights to lower payments. As a result of their actions, CFPB charges, Navient caused students to overpay for their loans, and harmed their credit scores, including those of disabled and veteran student borrowers.

Since its inception, the CFBP has recovered nearly <a href="http://chicago.suntimes.com/news/jesse-jackson-trumps-minion-prepares-to-gut-consumer-watchdog/">$12 billion for 27 million consumers</a> from lenders determined to have deceived borrowers, including vulnerable clients such as veterans and military families, students, seniors, people of color, and low-wage workers.

Though the Smart Campaign works mostly in developing countries, this suit highlights just how prevalent consumer protection problems are in all parts of the world, and importantly, how crucial it is to have advocates like the CFPB.

The Smart Campaign advocates full transparency in the pricing, terms, and conditions of all financial products. Lenders adhere to the Client Protection Principles by employing humane collection practices and high ethical standards in the treatment of clients. They give clients a way to address their complaints so they can be served more effectively. In essence, they ensure that clients receive services that are fair and respectful.

During his second week in office, the new President <a href="http://www.cnbc.com/2017/02/03/trump-signs-executive-order-on-financial-regulation.html">signed an executive order</a> directing the Treasury Secretary (still to be confirmed) to consult with regulators about potential reforms to the Dodd-Frank law which, among its many other provisions, created the CFPB. The Secretary’s report is due in the coming months. <a href="https://www.americanbanker.com/news/cfpbs-precarious-future-under-trump">Speculation is rife</a> that the administration will weaken the CFPB, for example, by <a href="http://fortune.com/2017/01/10/donald-trump-richard-cordray-consumer-financial-protection-bureau/">replacing its director</a>, and will propose more fundamental legislative changes to its charter. Keeping clients first and protecting vulnerable clients has been the business of the Smart Campaign, as it has of the CFPB. American financial consumers cannot afford to lose their chief advocate.

<strong>Have you read?</strong>

<a href="https://cfi-blog.org/2014/03/21/cfpb-gives-voice-to-clients/">CFPB Gives Voice to Clients</a>

<a href="https://cfi-blog.org/2014/01/22/cleaning-up-debt-collection-in-the-u-s/" target="_blank" rel="noopener">Cleaning Up Debt Collection in the U.S.</a>

<a href="https://cfi-blog.org/2016/09/19/wells-fargo-and-the-tuxedo/">Wells Fargo and the Tuxedo</a>

The U.S. Consumer Financial Protection Bureau and the Smart Campaign

Regulators

<em>&gt; Posted by Pablo Antón Díaz, Research Manager, CFI</em>

<img class="alignnone size-full wp-image-22666" src="https://centerforfinancialinclusionblog.files.wordpress.com/2017/01/img_9217.jpg" alt="img_9217" width="5616" height="3744" />

<em>Scott Graham, Daniel Rozas, and Pablo Anton-Diaz at the “Preventing Overindebtedness in the Microfinance Sector in Mexico” panel, XV National Microfinance Summit, Mexico City, Mexico, November 2016</em>

For the past decade, in part fueled by regulatory changes in the financial sector, there has been an explosion in the availability of credit to low-income individuals in Mexico. The Mexican microfinance sector has become increasingly concentrated and highly competitive. In 2015, the 10 largest microfinance institutions (MFIs) in the country represented <a href="http://www.prodesarrollo.org/benchmarking">81 percent</a> of the total market size, with more than <a href="http://www.cnbv.gob.mx/Paginas/PADR%C3%93N-DE-ENTIDADES-SUPERVISADAS.aspx">1,500</a> smaller MFIs sharing the remaining 19 percent.

Data from a <a href="http://www.finca.org/files/2014/05/Over-Indebtedness-in-Mexico-Its-Effect-on-Borrowers.pdf">study</a> of loan applicants to FINCA Mexico suggests that the vast majority of new loan applicants in Mexico already have active loans and that somewhat less than half of these individuals are already in arrears at their time of application. The growing evidence on overindebtedness and credit bubbles in some regions of the country is an issue that, if left unattended, could trigger severe problems.

The increasingly crowded Mexican microfinance market reflects very deep penetration of a very narrow slice of the population (microentrepreneurs in the lowest two income quintiles) and mounting pressure on new players that need to reach a healthy portfolio size in order to achieve long-term sustainability. To their credit, MFIs have made great efforts to overcome traditional geographical barriers, and the current reach of the microfinance industry covers more than <a href="http://www.prodesarrollo.org/benchmarking">90 percent</a> of the 2,500 municipalities in the country. Because of the type of customers being sought out by new players, and the already high concentration of competitors in densely populated areas, recent growth in the sector has primarily focused 0n rural areas with low Human Development Index scores. It is therefore not a coincidence that of the <a href="http://www3.inegi.org.mx/sistemas/sisept/Default.aspx?t=mdemo13&amp;s=est&amp;c=17503">five Mexican states</a> with the highest rural populations, four have the <a href="http://www.prodesarrollo.org/benchmarking">highest number</a> of operating MFIs in the country (Chiapas, Veracruz, Estado de México and Oaxaca). Three of these states also have the <a href="http://www.mx.undp.org/content/mexico/es/home/library/poverty/indice-de-desarrollo-humano-para-las-entidades-federativas--mexi.html">lowest Human Development Index</a> scores in Mexico (Oaxaca, Veracruz and Chiapas).

Indeed, the number and variety of lenders, along with the total volume of loans in the sector, have increased massively. It is safe to assume that most lenders are profiting under current conditions. What is less understandable is why so many lenders are willing to make loans with apparently little regard for the borrowers’ existing credit statuses. Institutions with proper credit discipline would theoretically avoid making risky loans for fear of write-offs and administration costs. But in Mexico, the current scenario - which includes, among other things, the highest interest rates in the microfinance world - allows some lenders to push the costs of reckless loans onto borrowers. Bad lending seems to be turning into good business in some states in Mexico – with customers paying the price.

<a href="http://www.finca.org/files/2014/05/Over-Indebtedness-in-Mexico-Its-Effect-on-Borrowers.pdf">A study</a> conducted by the Microfinance CEO Working Group (MCWG) using credit bureau data from FINCA Mexico’s loan applicants in all the main regions of the country is one of just a few studies attempting to gauge the severity of this problem in Mexico. The researchers found that almost 74 percent of new customers applying to FINCA already have loans elsewhere (with 55 percent having one or two, and 19 percent having three or more). Additionally, of the clients with outstanding loans at the moment of application, 44 percent were already in arrears. This incidence of arrears increased with the number of existing credits. For clients with two outstanding loans the incidence of arrears was 58 percent, with the number rising to almost 80 percent for those with four or more sources of credit. If we assume that the results of this study from one large MFI are representative of all microfinance applicants nationwide, it would imply an enormous number of microfinance clients in Mexico with multiple outstanding loans and an also enormous number in arrears.

In Chiapas for example, Mexico’s poorest state (with a population of almost 5 million), there are currently more than 30 registered MFIs in operation. Because of this, multiple borrowing is rampant, with the average urban client in the state carrying <a href="http://www.danielrozas.com/2013/02/14/whats-next-another-repayment-crisis/">four to five loans</a>, according to data analyzed by Daniel Rozas, while clients with as many as seven loans are not unheard of.

In November I had the opportunity to moderate a panel on overindebtedness at the annual “Encuentro Nacional de Microfinanzas” (The National Microfinance Summit) in Mexico, hosted by PRONAFIM, where some of these findings were underscored in front of a larger audience by both Daniel Rozas and Scott Graham, the researchers behind them. After listening intently to both researchers, it was heartening to see how many of the attendees that offered comments were well aware of this silent threat and in some cases had already started to take initiative inside their own institutions to come up with possible solutions to prevent a crisis.

PRONAFIM is a program managed by the Finance Ministry (Sectretaría de Economía) that provides funding for microfinance institutions. The Smart Campaign has worked closely with PRONAFIM to support client protection in the market for over a year. We announced during this panel that as part of the Smart Campaign’s close collaboration with PRONAFIM, we were working with them on how to strengthen their supervisory tools for the specific purpose of – among other things – preventing practices that can lead to the unnecessary overindebtedness of clients. This revamped tool will be launched by PRONAFIM in early 2017 and will be implemented as part of the annual supervisory visits that their compliance teams conduct with the MFI investees in their portfolio. This tool will help PRONAFIM to evaluate these MFIs against minimum industry standards in areas like transparency, prevention of overindebtedness, and responsible pricing practices to identify and correct harmful client protection practices within the institutions they support, and set an example for other competing institutions in the country. This tool is based on the Smart Campaign’s <a href="http://www.smartcampaign.org/certification/2-assess">Smart Assessment Tool</a>, which is used worldwide to examine an institution’s implementation of the seven <a href="http://www.smartcampaign.org/about/smart-microfinance-and-the-client-protection-principles">Client Protection Principles</a>.

<strong>Have you read?</strong>

<a href="https://cfi-blog.org/2016/07/01/mexico-launches-comprehensive-financial-inclusion-strategy/">Mexico Launches Comprehensive Financial Inclusion Strategy</a>

<a href="https://cfi-blog.org/2016/05/13/steering-financial-education-towards-creating-financial-capability-in-mexico/">Steering Financial Education Towards Creating Financial Capability in Mexico</a>

<a href="https://cfi-blog.org/2016/06/09/three-behavioral-implications-of-how-mexico-diaries-households-pay-for-healthcare/">Three Behavioral Implications of How Mexico Diaries Households Pay for Healthcare</a>

Growing Concerns about Overindebtedness in Mexico’s Microfinance Sector

Partnership for Responsible Financial Inclusion