Two Sides of a Default Coin

> Posted by Alexandra Rizzi, Deputy Director of the Smart Campaign, and Jami Solli, Independent Consultant and Founder of the Global Alliance for Legal Aid

Imagine you are a new microfinance loan officer in a rural area of your country and extremely proud to have found a stable, well-regarded job. Your sales territory, while requiring significant travel, is familiar – this is where your father’s extended family is from, and in fact, a few of the borrowers in your portfolio are distant cousins. You manage a portfolio of just under 300 borrowers, most of whom you see on a weekly basis.

This week, at one of the repayment meetings, you are approached by a client in distress and near tears. She apologizes that she is unable to pay back the outstanding balance on her loan due to circumstances out of her control, and asks for an additional six months to repay. Her fellow group members have been covering for her for the past two weeks and seem to be losing patience with her. Given that this was the woman’s first loan and that your country’s credit bureau covers only five percent of the microfinance market, you have no information on her credit history or current debt burden.

You remember an inexperienced colleague who was convinced by a group to reschedule their loans; unbeknownst to your colleague, the powerful group leader had absconded with the entire group’s money. Ultimately, the other members refused to pay for the leader’s fraud. Rumors about the incident and your colleague abounded and subsequently several other of his groups decided to default en masse. This loan officer, of course, is no longer working at your company. But, you imagine that something similar could easily happen to you too – it is all too easy for your entire, hard-wrought portfolio to disintegrate like a sand castle before your eyes. You wonder what to do next. At this moment, headquarters seems a long way from the realities of the field.

Imagine instead that you are a microfinance client and are struggling to make your weekly payments. At the start of your loan, your business – buying and reselling used clothing in the marketplace – generated enough income for your payments plus a little extra, but now the rainy season has come and sales are down. Each week, the days leading up to the meetings are filled with dread. You make ends meet by reducing how much food you eat, you delayed paying your children’s school fees, and even sold a goat. But now, your husband has contracted malaria and needs meds. The last three weeks have been impossible. While your friends in the group have covered for you, their patience has run thin, and you fear you will not be able to make payments for at least several months. You’ve heard rumors of what happens to clients who cannot pay back their loans – a reputation as a person who can’t be trusted, confiscated assets, late fees, black-listing from future credit, and years of follow-up from your creditor. Your friends say that MFIs are inflexible, even in the case of an emergency. You think your loan officer is a fair person, but dread the encounter at the next meeting. You even wonder if you should go at all. Maybe it would be wiser to go visit your in-laws in the neighboring town for an extended stay.

The Smart Campaign embarked on an exploratory study to better understand what happens to our loan officer, distressed borrower, and thousands of others like them. This week the findings from this research have been released in the CFI publication What Happens to Microfinance Clients Who Default? An Exploratory Study of Microfinance Practices.

Understanding what happens to clients who default is an understudied area in the microfinance sector. Thus in late 2013, the Smart Campaign and Jami Solli, Founder of the Global Alliance for Legal Aid, embarked on an exploration to help fill these knowledge gaps. The project interviewed 44 microfinance providers, as well as regulators, credit bureaus, researchers, and consumer advocates across three distinct markets – Uganda, India, and Peru.

The knowledge gaps related to default management included what providers actually do to collect loans, as well as what influence (if any) legal and regulatory frameworks have on industry practices. For example, what guidelines or boundaries does a country’s legal framework set on debt collection? Is there a prescribed manner in which MFIs can collect a past due debt? Are their rules on seizure, valuation, and the sale of collateral? Is there a limit to the length of time which a borrower is legally responsible for a debt? What are MFI practices regarding debt collection actions taken after a loan is written off? Are there any insolvency or personal bankruptcy mechanisms available to debtors, either by law, or through voluntary debt counseling centers? If a legal framework does exist, is there active enforcement? Are MFIs aware and in compliance with requirements? Additionally, we noted that there does not appear to have been any industry research on the consequences of default from the client perspective.

So, what happens to our loan officer and distressed borrower? Stay tuned for more from the results of the paper.

Have You Read?

“D” Is for Default

CFI Publishes ‘Over-Indebtedness of Microborrowers in Ghana’ by Jessica Schicks

Investigating What Happens to Clients Who Default