Microfinance's Latest Challenge: Cutting Back on Over-indebtedness Among Its Poorest ClientsPublished: December 07, 2011 in Knowledge@Wharton
Long before "99%" became a symbol of Occupy Wall Street, the microfinance industry used the number to describe the share of its clients -- poor entrepreneurs shunned by traditional banks -- who repaid their micro-loans on time. It's a number used less and less in microfinance these days -- not because of Occupy Wall Street, but because many micro-borrowers are starting to default.
"One of the major issues we face in Lebanon is the problem of over-indebtedness," said Youssef Fawaz, CEO of Al Majmoua, the leading nongovernmental microfinance organization in Lebanon. "We're noticing that clients ... drown themselves in debt by borrowing money from multiple institutions."
Fawaz was among 23 microfinance professionals who gathered at Wharton from November 28 to December 2 for the 3rd Annual Women's World Banking Advanced Leadership Program, a collaboration between the Center for Microfinance Leadership of Women's World Banking and Wharton Executive Education. Implemented in partnership with the MasterCard Foundation, the program brings together microfinance practitioners from around the world to study the latest thinking on business best practices, enhance their leadership skills and learn from each other.
Fawaz said over-indebtedness had become a problem in Lebanon because of the increased number of microcredit institutions, a lack of regulation and the absence of a strong credit bureau that would make it easier to identify clients who have multiple loans. "The information about whether [clients] have multiple loans or not is always hard to come by, so we have to guess," Fawaz noted. Sometimes after a loan is given out, "suddenly [recipients] cannot meet their repayment. This is how you uncover that this person has had two, three, four loans at the same time."
It's a world away from three decades ago, when banks ignored the world's poor, leaving many of them unable to borrow money at affordable rates. In the beginning, microfinance sought to alleviate poverty by giving out tiny loans to help people start small businesses. Popularized by Bangladeshi economist and Nobel Peace Prize laureate Muhammad Yunus and Grameen Bank, which he founded in 1983, the microfinance industry has since grown to hundreds of institutions serving more than 150 million borrowers worldwide.
But the last few years have brought growing pains to microfinance. As nonprofits proved the world's poor to be reliable clients, many of these same institutions transformed into for-profit lenders or banks, and rapidly expanded their outreach, along with their profits. Their financial success pointed the way for traditional banks and for-profit agencies to move into the market, thereby increasing competition. Lucrative initial public offerings from Mexico's Compartamos Banco in 2007 and India's SKS Microfinance Ltd. in 2010 triggered heated debate about profiting off the poor. Last year, in the Indian state of Andhra Pradesh, the local government restricted microfinance after a string of borrower suicides led to accusations of exploitation, harsh collection tactics and exorbitant interest rates. Controversy even spread to Bangladesh, where prime minister Sheikh Hasina declared microfinance was "sucking blood from the poor in the name of poverty alleviation." In March, Bangladesh's central bank removed Yunus -- still revered in the industry as microfinance's patriarch -- as managing director of Grameen Bank and exerted greater control over the institution.
Over-indebtedness and lack of repayment are now among the top concerns in the microfinance sector. In "Microfinance Banana Skins 2011" -- a recent survey of more than 500 microfinance institutions from 86 countries -- credit risk was cited as the number one concern among microfinance practitioners, investors and analysts. "Above all, credit risk is seen to reflect the fast-growing problem of over-indebtedness among millions of microfinance customers: poor people who have accumulated larger debts than they will ever be able to repay," concludes the survey, the third such report about the microfinance industryfrom the London-based Centre for the Study of Financial Innovation. Over-indebtedness could potentially lead to heavy loan losses among microfinance institutions, the report said, adding: "This problem is now so broad that it has the makings of a worldwide social/economic phenomenon."
'Bread Today, Hunger Tomorrow'
Political upheavals, widespread unemployment and the same global financial crisis that drove Occupy protesters into the streets have also had an impact on the world's micro-borrowers. Around the world, for a variety of reasons, once reliable microfinance clients are either defaulting or delaying repayment of loans because of more than just multiple borrowing.
The Arab Spring has impacted countries in the Middle East such as Egypt and Syria, Fawaz said. "All the political upheavals around the Arab world today are having a direct impact on the sector. In terms of social and political upheavals, people tend to become [either] delinquent or delay in paying, either because their business is suffering due to the instability, or simply because they think they can benefit from the instability."
Program participant Laura Amelia Trueba Contreras, marketing manager at Banco Adopem in the Dominican Republic, said high unemployment and financial turmoil in the United States and Europe were making it more difficult for her clients. "There's more inflation and less growth," she noted. The United States is the Dominican Republic's most important trading partner, importing sugar, tobacco, coffee, textiles and an array of other goods. So an economic downturn in the U.S. also impacts clients in the Dominican Republic. "We are very dependent on commerce with the U.S."
The downturn also impacts the flow of money from abroad, she added. "We receive a lot of remittances, especially from the States. There's a huge population of Dominicans in New York. So remittances are a very important economicaccelerator, one of the most important aspects of the Dominican economy," she said. "Since the economy is so bad in Europe and in the States, there's also less money on the streets -- less money to repay loans, less money for people to buy consumer products. So the microfinance sector is not doing as well for the repayment of the loans."
In Kenya, microlenders are working to educate clients about how to cope with fluctuating interest rates and rising inflation, said program participant Esther Muiruri, general manager of agribusiness at Equity Bank. "When the interest rates are fluctuating a lot, there are uncertainties about how much. And when there's inflation, the cost of money becomes very expensive.... Therefore, the cost of doing business is also very high."
Clients may also have trouble if their business depends on exports. Kenya exports coffee, black tea and fresh flowers to Europe, for example. "To the extent that countries are trading, like in Kenya [where] we have a lot of exports to Europe, certainly there's going to be some uncertainties in cost and pricing," she said.
Sometimes repayment problems are more political than economic. In countries such as Nicaragua, Pakistan and India, some government leaders have at times encouraged borrowers to stop repaying their loans, saying interest rates are too high. In other cases, local governments seeking political favor subsidize loans at below-market rates or give out credit without checking to see if the borrower can repay the loan.
"That doesn't help the people," noted program participant Paul Arias Guevara, CEO and general manager of Credife, the microcredit program of Banco del Pichincha in Ecuador. "It's just bread for today and hunger for tomorrow."
Problems with over-indebtedness are also caused by a lack of education, according to Arias Guevara. "Over-indebtedness comes when somebody offers to you more credit than [you can] manage. That's a problem with the microfinance clients and all clients," he said, pointing to examples of credit card debt and subprime mortgages in the United States. Over-indebtedness happens in "other socio-demographic sectors all around the world. Maybe [in microfinance] it's the worst because we're working with people who are poor."
Over-indebtedness, increased competition and other problems in the microfinance industry are part of its evolution, Arias Guevara noted, and can be solved if the industry works toward a more sustainable future. "Ten years ago, we were saying that more banks, more money needed to come into this sector because we are working with the poor people. And now they are coming and we are today saying, 'Please don't come!'"
Microfinance can still play an important role in poverty alleviation -- though not the only role, he said. "My personal thought is that when they say microfinance hasn't helped poverty much ... we are not responsible for lifting people out of poverty. When you give somebody credit ... but they don't have water, infrastructure or education, I'm sure that all our efforts [can] help, but not help enough."
That doesn't mean microfinance should abandon its work, practitioners say. According to the "Banana Skins" report, more than 2.7 billion people in the world still have no access to formal financial services. In Ecuador, Arias Guevara pointed out, "only 40% of our population has normal access to banking services. So we still have a lot to do."