Microfinance Focus, January 12, 2012: On the first day of a two-day virtual conference organized by CGAP, microfinance experts from across the globe examined various factors that contribute to multiple borrowing and over indebtedness among microfinance clients. The conference is organized in collaboration with IFMR (Institute for Financial management and Research) and MicroSave.

Moderated by Jesila M. Ledesma, the Regional Manager for South East Asia, MicroSave, Philippines, the opening session focussed on practices that can help microfinance institutions track the level of multiple borrowing, causes and signs of over-indebtedness and the role of MFIs in reducing it.

According to Noemi BOnaobra, multiple borrowing become dangerously close to over-indebtedness when clients borrow so they can pay off their loans from other MFIs/lenders. This is usually caused by free market and competition among MFIs, private lenders, and other providers. The first sign of over-indebtedness is inability of the borrowers to pay off the loans.

She feels that MFI practices are to a large extent responsible for the over- indebtedness among clients. These practices include targets imposed on loan officers which focus on numbers rather than quality. These targets are also imposed by donors and loan wholesalers on the MFIs.

“As early as 2006, the local MFIs in Philippines saw the first signs of over-indebtedness – high defaults and drop outs. We tried to check the maximum number of MFIs a borrower gets to interact with in one village. The figure was astounding. In one urban village a borrower can borrow from 8 MFIs. This prodded us to test if the policy is worth considering”, she said.

The effect of over-indebtedness goes beyond inability to repay loans. In some cases, the relationship with the members of the community suffers. In some extreme cases, members are forced to transfer to other villages to escape from the MFIs. These were gathered by the MFIs in the informal studies and interviews that they conducted, she explained.

Elaborating on how clients handle multiple borrowing, Johan Diaz shared a small study conducted by MicroSave. The study finds that in managing their basics, clients have varied financial needs that can be categorised into 3 main groups: for business and other income generating activities, for basic needs of the family, especially educational expenses of children, and for meeting emergencies such as sickness. Not only are these needs varied, they are also irregular and some very risky. Because of this variety, clients tend to prioritise these expenses.

“Even for multiple loans, clients prioritise which credit provider to pay first, based on factors such as leniency of the institution, timing of payments, and loan size”, he said.

Wu Wei, a participant highlighted that multiple lending could also be a challenge in China even though the institutional framework of microfinance is imperfect. Clients in urban area are able to finance their business by microloans from multiple resources, despite those in rural area are still unsatisfied.

“However, since the absence of credit bureau, MFIs have little access to identify the lending history of their client, particularly in the cities. The problem could be evident with the rapid development of Microcredit institutions in recent years”, Wu Wei said.

Ganga Tilakaratna shared some of the key findings based on a study that he completed recently in Sri Lanka based on a two-period survey (2006/07 and 2009.10) that was conducted covering 450 households from 3 districts.

The findings revealed that by the second round of the survey in 2009/10, over 70% of MFI borrower households in the three districts surveyed, have borrowed from multiple financial institutions (FIs)-more than double the level in 2006/07. Interestingly, the majority of them have borrowed from a combination of MFIs and other institutions like commercial banks (loans from commercial banks are largely agriculture credit or pawning).

Multiple borrowing among these households has been driven by their diverse needs- e.g. income-generation activities, housing, consumption, dealing with some risk/emergency.

“Despite the high and increasing level of multiple borrowing in the sector, my study reveals that the debt levels among the households on average were at a moderate level (in 2009/10) – with a mean debt-income ratio of 0.13 for the overall sample and 0.15 for the multiple borrowers. Around 80% of the MFI borrowers (and multiple borrowers) have debt-income ratios of less than or equal to 0.25 by 2009/10 while only a small minority spend more than 50% of their income on debt repayments. However, the debt levels among these borrowers on average have increased between the two survey periods bringing some concerns”, he said.

Adding to this, Jesila Ledesma said that MicroSave has done a similar study in the Philippines which also affirmed the positive benefits of multiple borrowing among clients. Among multiple borrowers, a higher percentage of debt payment over the weekly gross income at 33% has been recorded.

Rose Rivera however suggests that microfinance institutions can contribute in reducing the risk of multiple borrowing by reviewing their motivation while expanding. Expansion can mainly be growth driven or a combination of growth and responsible provision of finance to the unbanked. The former tends to take on any market for that matter while the later may think twice when it enters or continues presence is overcrowding the market.

“When supply abounds and prices become competitive, the industry will have to contend with ‘commoditization’ of a product or the microfinance loans in our case. This is what we are confronted at this stage”, she said.

Girija Srinivasan further added that clients borrow from several sources other than MFIs – friends and relatives, other groups (Self help groups, chit funds) and sometimes from main stream banks. It is a real challenge to track the borrowing from several sources. Credit bureaus are useful mechanisms to track client level borrowing from other institutions which share data with the bureaus.

However, the banks are not part of this arrangement and clients’ borrowings from self help groups which are linked to banks are not available. Thus it is difficult to gauge the level of indebtedness and to judge whether the clients are over indebted. Credit bureaus provide only partial answer. So MFIs usually restrict the number of loans the client can take from other MFIs.

As long as client specific needs are not understood and met, multiple borrowing will continue. MFIs need to invest in understanding client needs and developing suitable products .Even when MFIs have suitable products whether this will stop clients from borrowing elsewhere is a concern. Financial education and consequences of over indebtedness have to be explained and reinforced periodically, he said.