Microfinance Focus, January 13, 2012: During CGAP’s virtual conference session titled ‘Does commercialization of MFIs foster over-leveraging?’, Alex Silva, the Chairman of Omtrix said that pressures for over-lending are coming from both inside and outside. “However, mostly from the outside, that is form investors demanding high returns”, he said.

“This would translate in pressure to the Board Members to demand said results from Management. Not enough discussion is going on at the Board level on these issues. The correlation between overleveraging and long term poor results is not black and white. More research is clearly needed”, he said.

Moreover, Alex highlighted that many “consumer lenders” build into their revenue models a very high default ratio and compensate by charging very high rates and/or penalties/fees.

In the case of microfinance however, one should consider the nature of the borrowers. “In most cases of consumer borrowers this sector is but a small percentage of the lending organization/bank overall portfolio and thus one could argue that default rates can be kept “in check” by reducing exposure to that particular sector while collections are intensified”, he said.

More important, in the case of consumer lenders, each borrower is independent of its peers. In the case of microfinance, contagion (other borrowers not paying as result of some not paying) is more prevalent.

Furthermore, as was seen in India and Nicaragua, once microentrepreneurs start defaulting, political risk is very real and the authorities might be tempted to intervene

Elisabeth Rhyne added that a business model that allows for a significant number of defaults, is unconscionable, even if fee and income revenue cover the losses. Loan defaults have severe repercussions for defaulters in all but the least developed societies.

“I first noticed this when looking a long time ago at the U.S. Small Business Administration loan guarantee program, which ran a 9-11 percent loss rate. A very high percentage of those defaulters lost their homes which secured their business loans. Defaulters faced business collapse, loss of home, and loss of credit rating all at the same time”, she said.

Speaking about the role of regulators, Rafe Mazer said, “Usually I’m a bigger believer in regulation than private-sector efforts if we want to get serious with consumer protection and issues like overindebtedness. But here I’m a bit reluctant to propose a strong role for the government in putting forth governance requirements, especially if they treat different provider types selling similar products differently (such as tougher standards for credit-only MFIs than consumer lenders) since it could easily turn into an unbalanced playing field. Not going to name any names, but there are a few new laws across the globe on consumer protection that unfortunately have elements of this in place, which I think is not a fair approach”.

Alex added that while regulation in some cases is warranted/needed, adherence to solid consumer protection principles (such as those sponsored by, among others, the SMART Campaign) coupled with strong education of the negative impact on the bottom line of not keeping the consumers best interests in mind would seem to be the best solution.

The conference themed ‘Understanding Multiple Borrowing and Avoiding Over-indebtedness Among Clients’ was organized by CGAP in collaboration with IFMR (Institute for Financial Management and Research) and MicroSave.