When does a borrower cross the line from leveraged into losing it? Every borrower wants to avoid sliding into debt stress. Lenders, too, have a stake in ensuring that their clients cope successfully with their debt burdens.
If no one wants debt stress, why is there so much of it around?
This is an emerging challenge for the microfinance institutions around the world that have finally succeeded in providing access to credit to hundreds of millions of previously excluded low income people. Some of the top microfinance markets in the world - in countries as diverse as Nicaragua, Morocco and Bangladesh - are becoming saturated. Since their clients are among the world's most vulnerable people, microlenders have a special responsibility to avoid over-lending. This brings up a new problem for microlenders: how and when to put on the brakes.
If you are going to prevent debt stress, or as it is known in microfinance circles, overindebtedness, you'd better have a clear definition of the phenomenon. Surprisingly, though, what seems like a simple concept - too much debt - is devilishly hard to pin down.
Overindebtedness is sometimes equated with multiple borrowing. In many markets where microfinance has grown fast, microlenders crowd in to compete with one another to reach a finite number of customers. In these settings, poor clients often take loans from several competing lenders. Some may even use one loan to pay off another. Is that overindebtedness? Not necessarily.
Middle class people often juggle credit cards, mortgages, car and school loans successfully, and the same goes for the poor. A pathbreaking book published in 2009, Portfolios of the Poor: How the World's Poor Live on $2 a Day, reveals that the vast majority of the world's poor lead complex financial lives. They continually tap relatives, employers, savings clubs, and informal moneylenders to keep their financial lives on track.
It is not uncommon for a poor household in Bangladesh or South Africa to "turn over" -- borrow, lend, deposit, withdraw -- ten times the net household worth in the course of a year. Rapid turnover is necessary in large part because the incomes of the poor tend to be uneven and unstable as well as low. They need financial intermediation to tide them over periods of little or no income.
If poor people already have many financial arrangements at a time, then multiple loans from microlenders are not alone evidence of a problem. It's the stress in debt stress that needs to be examined.
The definition of overindebtedness I favor, developed in dialogue with Richard Rosenberg of the Consultative Group to Assist the Poor, who has explored the question in depth on the CGAP blog, revolves around the idea of sacrifice. If a family has to make sacrifices that significantly affect their quality of life, or if a micro-business has to make sacrifices that reduce its income generating capability, that's debt stress.
Many people get into debt stress at some points in their lives. They scrimp on groceries for a couple of weeks to have the cash for next month's loan payment. Or they miss loan payments because a lingering illness keeps them away from their business. That's acute overindebtedness. While acute debt stress can be serious, some temporary overindebtedness is a normal part of the ups and downs of life; it might not mean that a person has borrowed too much.
I worry more about it, however, when it turns chronic. If a person routinely has to borrow from one lender to pay off another, that's chronic. If quality of life sacrifices go on month after month, that's chronic. If a business reduces its earning capacity, a downward spiral can result. For the poor, life with chronic debt stress can move them from "vulnerable" into "suffering".
What is a microlender to do? A socially motivated microlender might aspire to ensure that a loan never makes a client worse off, a worthy Hippocratic goal, but one that is patently unachievable. The best a lender can hope for is to ensure that the amount of debt stress their loans induce is kept to a tolerable (and that means very low) level.
The crucial time for a lender to avoid creating debt stress is at the point of credit approval. In the developing world, credit bureaus are generally weak or non-existent, so lenders approve loans with a gaping absence of information about their clients' existing indebtedness. Credit bureaus that can help with this problem are needed urgently. But creating effective credit bureaus takes years.
Another approach is to use the rate of delinquency and default as an indicator. But, not all debt stress shows up as default - or not until months after lending decisions are made.
In the absence of other means, it makes sense for lenders in microfinance "hot spots" to talk with clients directly. I recommend regular surveys that ask questions at the heart of chronic debt stress. "In the past month, have you borrowed in order to repay a loan?""Do you often go without meals in order to repay a loan?"
Lenders would have to learn how to interpret the answers and hone the questions to their own client segment. Still, repeated use of questions like this should reveal trends and give microlenders a working sense of when they're entering troubled waters.
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