The Microcredit Balancing Act

“Microcredit lenders have long experienced low levels of delinquency and default, but recently, collection problems have appeared in some major markets,” authors Jessica Schicks and Richard Rosenberg argue in their recent paper “Too Much Microcredit? A Survey of the Evidence on Over-Indebtedness.” They go on to suggest that, if nothing is done to overcome this problem, microcredit borrowers are more likely to become over-indebted as markets become more competitive.

While the main goal of the microfinance movement has been to increase delivery of financial credit to low-income clients, the authors suggest that “a rapidly increasing number of microcredit markets, especially regional markets within a country, are becoming more competitive and even nearing saturation.” This situation tends to increase over-indebtedness: lenders, in their quest to acquire additional market share, turn to higher-risk borrowers.

The concept of over-indebtedness, as defined by the authors, is not restricted to situations in which the borrower is completely unable to repay. Rather, it incorporates a range of borrower struggles to make repayments, such as cutting back on basic consumption, education, or health care. Thus, the authors believe that borrowers are over-indebted when they have serious problems repaying their loans, even if they are making repayments.

Schicks and Rosenberg show how multiple factors contribute to over-indebtedness, including the behavior of both lender and client. They find that some lenders conduct over-aggressive marketing or provide inflexible loan products. They also explain how clients often use their loans for consumption, rather than for investment in a productive activity.

The authors emphasize that the only way to completely eliminate over-indebtedness is to stop lending or, at least, to restrict borrowers’ access to microloans. Therefore, the purpose of the paper is to examine and suggest solutions “to reduce the prevalence of over-indebtedness to reasonable levels.”

To prevent over-indebtedness, Schicks and Rosenberg contend that lenders should improve product design, underwrite loans, willingly renegotiate loans, offer staff training and incentives, and adopt audit policies. Donors, in turn, should factor over-indebtedness risk into their evaluation of microlenders as potential grantees, and evaluate the saturation level of the particular market.

Schicks and Rosenberg caution, however, that reducing over-indebtedness can have a negative impact on borrowers’ access to credit. Thus, they conclude:

[T]here is some degree of trade-off: We cannot maximize borrowers’ access and minimize debt risk at the same time.

Microfinance is a delicate balancing act involving clients, lenders, and donors.