Over-indebtedness and Competition Among

Microfinance Institutions Theory and Evidence

Luis Allain
Sandipan Patra

FrankfurtSchool.de

Outline
Introduction
Client over-indebtedness and MFI competition - What are the links?
Oversaturated markets due to competition among MFIs
Aggressive lender behavior
Competition among MFI employees
Psychological biases of borrowers

Over-indebtedness crises in microfinance - Case studies

Andhra Pradesh
Bolivia
Morocco

Policy implications: How can negative impacts of competition on MFI clients be

mitigated?
Credit Bureaus
Regulation on microfinance
Financial literacy

Conclusion
FrankfurtSchool.de

Introduction
Client over-indebtedness and MFI competition - What are the
links?
Over-indebtedness crises in microfinance - Case studies
Policy implications: How can negative impacts of competition on
MFI clients be mitigated?
Conclusion

FrankfurtSchool.de

Introduction
Competition among MFIs has been quite a debated issue. It has shown
both negative and positive impacts
In this presentation we are trying to discuss the links between
competition and over-indebtedness of MFIs clients. We also aim at
presenting some of the measures that have been adopted to mitigate the
negative impacts of the competition

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Introduction
Recent rise in microfinance industry has attracted new entrants and it
has evolved from a donor-charity driven microcredit to the provision of a
wide range of small scale financial services to those segment of
population
MFI based on strong MFI client relations
Competition among MFI may lead to low screening and lending
standards
Increased competition associated with increased information asymmetry
which makes it difficult for MFI to know about general debt level of clients

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Introduction
Increased competition among MFIs shows:
Lower outreach
Lower repayment rates (high level of defaults)
Poor portfolio quality
Lower financial performance
Increased competition among MFIs client perspective:
Less repayment obligation
Multiple borrowing
Heavy debt burdens

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Introduction
Client over-indebtedness and MFI competition - What are the
links?
Oversaturated markets due to competition among MFIs
Aggresive lender behavior
Competition among MFI employees
Psychological biases of borrowers

Over-indebtedness crises in microfinance - Case studies

Policy implications: How can negative impacts of competition on
MFI clients be mitigated?
Conclusion
FrankfurtSchool.de

Client over-indebtedness and MFI competition

Oversaturated markets due to competition among MFIs

Apparition of an attractive market leads to many players (MFIs) coming
to it to do business in order to show better outreach and profit
At some point, this causes an excess availability of credit that eventually
cannot be repaid
This issue can be exacerbated when different institutions come into play,
like commercial banks in a MFI-only market, which may not know the
proper lending technology or have adequate products for the clients
Lack of adequate information and information sharing between lenders
decrease the effectiveness of credit evaluation and selection of viable
borrowers

External shocks Overcompetition can trigger risk of overindebtedness by asymmetry of information and presence of multiple
lenders
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Client over-indebtedness and MFI competition

Aggressive lender behavior

Excessive marketing and growth focus
Aggressive sales techniques exploits psychological biases of borrowers
and generates pressure to keep borrowing
Aggressive debt collection methods can cause additional or
unnecessary stress on still viable borrowers
Growth rate among MFIs demand employee growth, which paves the
path for recruitment of inexperienced loan officers or outsourcing of some
of the MFI loan process (client referral, client screening, debt collection) to
third parties

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Client over-indebtedness and MFI competition

Competition among MFI employees

Volume focused incentive system (credit officers rewarded for loan
disbursements)
This focus can cause a reduction in proper risk evaluation standards
(worse loans being granted due to relaxed credit risk management
policies)
It has been observed that productive employees become also in demand
from other institutions (specially when commercial banks enter into the
market), which creates more incentives to issue loans

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Client over-indebtedness and MFI competition

Psychological biases of borrowers

It has been studied that human beings are not homo economicus
rational, and that there are some psychological biases regarding
Value of present consumption vs. future reduction of consumption
(cognitive bias on short-term relevance)
Optimistic approach to own ability to repay a loan, given loan offers
(overconfidence bias)
Difficulty of quickly adapting consumption patterns to changing levels
of income (habit persistence)
Inability to properly estimate event probabilities one seldom
experience (available heuristic bias)

Excessive competition allows borrowers to have access to multiple

lenders, hence reducing repayment incentives given the presence of
alternate credit sources
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Introduction
Client over-indebtedness and MFI competition - What are the
links?
Over-indebtedness crises in microfinance - Case studies
Andhra Pradesh
Bolivia
Morocco

Policy implications: How can negative impacts of competition on

MFI clients be mitigated?
Conclusion
FrankfurtSchool.de

Overindebtedness crises in microfinance

Andhra Pradesh (2010)

Extensive presence of self-help groups (SHGs) since 1980s
SHGs extended training and other non financial services to rural areas
Bank linkages to SHGs started and, by using these links, SHGs started
granting bigger loans
By 2010 there were 4.5 million SHGs with 58 million members
In two decades many non-profit organizations transformed into
commercial MFIs
Rapid Growth of the MFI sector and Focus on Andhra Pradesh
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Overindebtedness crises in microfinance

Andhra Pradesh (2010)

2005- 2006 crisis emerges shutting down of 50 branches of 4 MFIs
Rise of competition among MFIs and SHGs.
Double dip: SHG members have two loans, and additional loans from
commercial lenders.
Government intervention, under allegation of MFI illegal operational
practices (including deposit taking), high interest rates and aggressive debt
collection techniques by agents linked to incidents of farmer suicides.

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Overindebtedness crises in microfinance

Bolivia (1999)
In 1990, commercial banks and non-regulated microlenders combined
reached only 120,000 borrowers.
In 1995, BancoSol had 63,038 borrowers and Caja Los Andes 15,954
borrowers. Together, they shared around 40% of the microlending market.
These are impressive numbers considering that in 1995 the whole
commercial bank sector (excluding BancoSol) reached only 126,912
borrowers (about 66% increase from 1990).
By Dec.1998, the microlending sector as a whole reached 415,609
borrowers. BancoSol and Los Andes together accounted for 43% of the
microfinance portfolio and 30% of all clients.
By mid-2001, the total number of borrowers had declined to 378,037 (a
decrease of 9% from 1998).

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Overindebtedness crises in microfinance

Bolivia (1999)
Since the early 1990s, the population of borrowers reached by Bolivian
lenders exploded, as a number of diverse microfinance providers entered
to supply the market.
By the end of the decade however, a combination of intense
competition, limited information sharing amongst micro lenders, and a
deep recession in 1999 brought this expansion to a halt.
Excessive competition amongst lenders weakened borrower discipline.
Bolivia experienced an inflow of consumer lenders offering products
similar to microfinance products in terms of loan amounts, terms and
prices but using consumer lending techniques
There was also evidence of multiple borrowing from different lenders.
After the crisis erupted, debtors associations appeared that have
adversely affected repayment behavior across the sector
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Overindebtedness crises in microfinance

Morocco (2007)
For a decade, the Moroccan microcredit sector was a rising star,
boasting top-performing institutions enthusiastically supported by local and
international funders. Morocco boasted 40% of client outreach in the Arab
world and hosted some of the best performing MFIs in the world.
Outstanding loans: from 300,000 in 2003 to 1.35 million in 2007.
It had a clear regulatory framework, but for microcredit-only
nongovernment organizations. Financial support (government and donors).
Commitment of local banks to funding MFIs.
However, credit risk (NPL30+write-offs): from 0.4% in 2005 to 13.7% in
2009
Multiple lending above 45% in 2007
ROA: 9% in 2003 to 0% in 2008
In 2012, there were only 800,000 loans
Credit risk around 10% and Multiple lending < 15%
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Overindebtedness crises in microfinance

Morocco (2007)
2007: Global credit crisis and serious floods in Morocco
MFIs implemented some product diversification but suffered from weak
governance and risk management
Overstretched MFI capacity (field and headquarters) Lenient loan
underwriting and monitoring
Multiple lending with no credit bureau
Introduction of consumer lending techniques or products
Credit risk in 2007 was only 2.3%, but its extent was hidden by the
astonishing growth of the loan portfolio
Response to crisis: swift response from the Central Bank (assuming the
role of regulator) - Funders maintained lines of credit - Efficient short-term
recovery - Long-term measures being implemented
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Introduction
Client over-indebtedness and MFI competition - What are the
links?
Over-indebtedness crises in microfinance - Case studies
Policy implications: How can negative impacts of
competition on MFI clients be mitigated?
Credit Bureaus
Regulation
Financial Literacy

Conclusion
FrankfurtSchool.de

Policy implications

Credit Bureaus
Pros
Better information Better allocation of available credit (monitoring
effect)
Good clients are rewarded with better interest rates / loan conditions
Challenges
Marginalized clients: poorest and potentially good
Little effect on existing clients (forward-looking measure)
Incentives to compete for good clients (pressures on new loans)
Potential social issues if clients dont understand how CBs work
Effectiveness depends on information availability (India: 25% of the
market; Bolivia: amnesty granted to borrowers who pay off past due
loans in public CB)
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Policy implications

Regulation
Areas subject to improve by adequate regulation
Enhanced risk management of MFIs
Better product information for clients (adequate disclosure of terms
and conditions)
Clear rules regarding loan issue and debt collection
Improved consumer protection and recourse channels
Challenges
Excessive or inflexible regulation exclusion of good clients
Formal vs. non-formal MFIs
Weak stakeholder self-regulation Donors not always involved
Political interference
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Policy implications

Financial Literacy
Pros
Improve awareness of day-to-day financial management and
understanding of terms and conditions of financial products
Improve awareness of clients rights and obligations
Can be focused through specific media or deployed massively through
formal educational channels
Challenges
Quick tips vs. formal education
Orthodox vs. unorthodox methods
Difficult to alter long-time habits and make up for education
shortcomings
Who should provide it? Different answers, different objectives
Doesnt affect the poorest clients
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Introduction
Client over-indebtedness and MFI competition - What are the
links?
Over-indebtedness crises in microfinance - Case studies
Policy implications: How can negative impacts of competition on
MFI clients be mitigated?
Conclusion

FrankfurtSchool.de

Concluding Remarks
Competition has good effects on MFIs: better conditions, better products
or services.
However, competition has some serious adverse effects if run
unchecked.
The case studies present how competition did affect those markets, and
provide some explanations about what went wrong and what was missing.
The theory and these case studies hint at some policy actions that could
help strengthening the MF market. However, these actions have
implications as well and present challenges for their application.
Designing a proper package of measures should be of crucial interest for
related stakeholders, including practitioners, donors and the government.
Final question Is microfinance the promised cure against poverty?
Suggestions considering extended outreach and risk of overindebtedness
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Over-indebtedness and Competition Among

Microfinance Institutions Theory and Evidence

Any questions?
Thank you for your attention!

Luis Allain
Sandipan Patra

FrankfurtSchool.de