Overindebtedness is like the unwelcome spectre at the feast. Amidst robust and exciting discussions about technology, product development, distribution innovations, client protection and rural finance at a conference like European Microfinance Week, overindebtedness is always there – hovering. It’s the underlying trigger of market crises. It’s what outsiders who’ve read a few alarmist headlines think about microfinance. And yet again, this year’s Banana Skins survey of industry risk (co-authored by e-MFP’s Daniel Rozas and me) found it to be by some margin the greatest perceived risk to the industry according to expert respondents from around the world.
It’s only right then that the Day Two plenary session should bring together industry leaders from the key markets of Bangladesh, Morocco and Mexico to discuss how the spectre of overindebtedness has emerged, and in some cases been addressed, in their countries. Daniel Rozas moderated the Plenary session, entitled “Managing Overindebtedness: Speaking from Experience”, alongside Shameran Abed, Fernando Fernandez, and Youssef Bencheqroun.
Shameran Abed needs little introduction, as the Director of the Microfinance Program at of Bangladesh’s BRAC – one of the largest MFIs, and the largest NGO-MFI, in the world. As a series of papers produced by CGAP have detailed, Bangladesh is the case of the cautionary tale averted. In 2007-08, there were several signs of market overheating, but a rare example of prudent self-regulation took place. A few of the largest MFIs – BRAC among them – took active measures to slow their growth.
As Shameran points out, Bangladesh is a unique market in some key respects, among them that, as the first mature microfinance market, it was grown from NGOs rather than foreign-funded commercial entities, especially from the 1970s to the early 2000s. Huge growth began early that decade as commercial investment began to pour in, but by 2007 real issues were emerging. Already endemic multiple lending/borrowing was worsening. The staff-client interface was increasingly strained – in part a result of growing pressure to reach targets. The Bangladeshi model, with its genesis in joint liability group lending but which had transitioned to individual lending but still within a group model, had changed. Groups became less cohesive, and institutions like BRAC less able to rely on groups to provide feedback on individual borrowers’ status, indebtedness and creditworthiness.
As Shameran tells it, an iterative series of discussions took place, and a consensus developed, within and between key large institutions, that asset quality would deteriorate without growth of 30-40 per cent per annum being actively slowed. The dominance of NGOs in Bangladeshi microfinance was a boon: the social roots of the industry and concern for client welcome made it easier to get Boards on board, so much so that they acquiesced in actions which led to BRAC not only slowing, but contracting – from 2900 to 2200 branches in 2009, and from 6 to 4.5 million active borrowers.
Slowing growth was part of it, but not all. Shameran says they were all well aware of multiple borrowing, and the risks it could pose. But why was it commonplace? Was it that the loans weren’t big enough to be useful – sending clients to other MFIs for what they need?
Interestingly, no – the problem was timing. Clients need a couple of hundred dollars now, and know that they’ll need a couple of hundred in a couple of months, and perhaps a hundred a month after that – the consequence of seasonalities and predictable calendar events for which credit was necessary. What they didn’t particularly want or need, in this case, is five hundreds dollars right now. The rigid 12-month loans were inappropriate to their needs, so they would spread them out so were getting the credit they needed when they needed it. Moreover, clients – like institutions – are conscious of spreading risk. They borrow from multiple organisations so that if their relationship with one were to sour, they’d retain access to credit from another. BRAC adapted, with more flexible loan terms, refinancing and rescheduling options, top-up loans, and emergency loans.
And while it wasn’t BRAC alone, its actions – along with those of its competitors – helped avert a crisis.
Morocco wasn’t quite so fortunate (or prescient). Youssef Bencheqroun is Director General of Al Amana. As many will know, Morocco was one of the countries, with Bosnia, Pakistan and Nicaragua, which suffered market crises in 2007-2009 – followed by AP/India a year after. Youssef attributes several factors to what happened.
Three large organisations dominate microcredit in Morocco. Following a period of “infancy and growth” (which saw 50-100 per cent per annum industry growth in the years up to 2007, couple with 99 per cent reported repayment rates and sub-five per cent PAR-30), the absence of credit bureaus; a cultural Muslim scepticism or misunderstanding of concepts of debt, interest and obligation; consolidation; reach into very remote and high risk areas; and the collapse of the second largest MFI in the country, caused a perfect storm.
The regulatory authorities were ‘frightened’, which led to the absorption of the collapsing MFI by the third largest – a subsidiary of a commercial bank. But not before some belated, self-regulation took place. The three dominant organisations set up a de facto credit bureau – pooling their client data each week. Growth slowed from 35 to 10 per cent – what Youssef calls an “incompressible figure”. Action was taken to stem overindebtedness. Strict limits were imposed on renewing loans to some clients. More mainstream tests for credit-worthiness were imported from mainstream commercial finance. And the Central Bank, not before time, set up credit bureaus – which now give institutions “a 360 degree view of reality”.
The actions meant the industry weathered the storm, but not without considerable costs. The problem, Youssef thinks, is that the organisations in the country lacked the ‘DNA’ to manage risk. The price that’s been paid is the difficulty in encouraging healthy, manageable growth. “Rate of growth depends on risk appetite or aversion; clients love us, but the current environment isn’t supportive to microfinance, meaning it’s difficult to get beyond ten per cent growth.”
Public opinion turned against microfinance in Morocco, and has not rebounded. And the industry needs public support to be able to develop, says Youssef in conclusion.
Daniel points out that it’s easy to conflate overindebtedness and multiple borrowing (something he and I know well from reading the responses to and writing the Banana Skins survey) but they’re distinct. Multiple borrowing and repayment risk can be driven by many factors, only one of which is overindebtedness. Likewise, clients can become overindebtedness for various reasons – only one of which is borrowing from multiple institutions at the same time.
Multiple borrowing, as he pointed out with some startling charts, is perhaps most endemic in Mexico. Fernando Fernandez heads up Pro Mujer in Mexico, the first MFI to get certification by the Smart Campaign. According to recent data from Finca, the percentage of microfinance clients in Mexico with more than four concurrent loans is more than double that seen in Bosnia in 2009, Morocco in 2008 or Andhra Pradesh in 2010. If this data is representative of the industry in that country as a whole (and it’s not clear it if is), Mexico’s microfinance industry could be on the brink of collapse.
Mexico is as unique as Bangladesh – but for very different reasons, to do with context. In 1995 a financial crisis decimated the banking system. For the following several years, financial services in Mexico was dominated by five international banks. It wasn’t until the 2000s that credit markets were properly re-activated, and the Mexican government went, as they say, “all in” – deciding to create and promote credit entities providing housing, mortgage and car loans. Consumer credit exploded – led by the (in)famous Compartamos Banco, whose 2007 IPO, the first in the global industry, on the back of three-digit interest rates, caused widespread concern among more socially-focused observers.
This is all-important, Fernando says, because it shows that Mexico wasn’t led by a tradition vision of financial inclusion microfinance – small loans, ostensibly for microenterprises, with the goal of financial inclusion. The focus instead was very commercial: profit maximisation through consumption lending. Provide debt, and do it as profitably as possible. This model naturally has high returns, but it is important to question, he says, why interest rates don’t in reality go down – as competition ought to mandate.
This wasn’t the private sector left untrammelled which caused this, either. On the contrary, it was seven years before the spate of market crises, that the government approved the operation of specialised banks to fill the gaps in the internationally-dominated market, three of which offered consumer credit for household goods, in all states of Mexico, and which followed Compartamos’ lead. Inclusion isn’t a priority. Providing credit to the base of the pyramid, however, is.
It has been, within those parameters, a massive success, with 30 million such clients within five years. But the number of people marginalised by the system is growing too, says Fernando. The search for profits and the appetite for risk are so high that some have been left out of the market – genuinely financially excluded from a system that has commoditised credit, with no focus on client protection. Today, the authorities in Mexico are wise to this, but it’s not clear what can or will be done.
What’s also not clear is how widespread overindebtedness is. The representativeness and replicability of the Finca data isn’t clear. It’s not clear, Fernando says, whether overindebtedness is limited to individual consumer loans, or has contaminated ‘productive microcredit’. It’s not clear if it’s localised to certain over-concentrated regions. These are ‘grey zones’, and more research will be needed to understand it.
There is an opportunity here, too. “This can perhaps be a signal that time has come to improve efficiency; we are vey inefficient in granting credit, the machinery that operates on the market is inefficient and price of products pay for the inefficiency, with high social cost and therefore high social risk”.
But the market leaders, for the most part, are not like the social visionaries in some other markets, and the commercial focus “allows us to say [the industry as a whole] is doing deep financial inclusion, when that isn’t always true”. Pro Mujer is unusual in this hyper-commercial market – the first to pursue and get Smart Campaign certification, and an organisation which, he argues, is trying to figure how not just what is profitable but who do we want to serve an why. Women in the poorest segments are Fernando’s priority.
But there is a long way to go in Mexico. For the most part, MFIs follow the logic of the mass market, consumer lending competitors: quick returns and low-hanging fruit, with little interest in the complex and expensive job of training clients. Instead, the mindset is to let someone else do that, and “we’ll get them on their third or fourth loan”. But microfinance still makes up only less than one per cent of the financial services sector as a whole. Which means nobody sees it as an existential threat. The risk, Fernando says, is social, and reputational.
Fernando believes something echoed by Shameran, Youssef and Dan – that overindebtedness is managed, mitigated or averted when institutions go back to basics. Think long-term. Recognise that they are in the business of relationships with clients, and not transactions. Institutions need to set limits. Strengthen these relationships. Collaborate with competitors. Diversify and adapt demand-driven product offerings. Be there when clients need them. Invest. And be mindful and vigilant with respect to the warning signs of overindebtedness.
The problem is that not all industry leaders are like these three men. It’s the others out there who will need to follow suit.