> Posted by Jami Hubbard Solli, Senior Policy Advisor, Consumers International UK

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What really happens to microfinance clients who do not repay their obligations?

As a late-comer to microfinance in 2005, I bustled from the Boulder training, to the Blue Book conferences, to the MicroCredit Summits (and back), trying to understand the dynamics of microcredit. At all these events, I heard proclamations of very high repayment rates, which sparked curiosity about what happened to that small percentage of borrowers who couldn’t (or wouldn’t) repay their microloans. This topic wasn’t presented at any conference I attended.

There has been industry research done on why clients default, as well as interesting work highlighting the gap between providers’ and borrowers’ perceptions and experiences related to over-indebtedness.¹ However, there is very little work done that details the actions taken by practitioners when a borrower doesn’t repay, nor on the experience for defaulting clients in the short-term, or over time.

The knowledge gaps on default management include what providers actually do, as well as what influence (if any) legal and regulatory frameworks have on industry practices. For example, what guidelines or boundaries does a country’s legal framework offer on debt collection? Is there a prescribed manner in which MFIs can collect a past due debt, including how to go about the seizure, valuation, and the sale of collaterals? Is there a limit to the length of time which a borrower is legally responsible for a debt? What are MFI practices regarding collection post write-off? Are there any insolvency or personal bankruptcy provisions available to debtors, either by law, or through voluntary debt counseling centers? More importantly, if the legal framework does exist, is it enforced? Are MFIs aware and in compliance with requirements? And, lastly, there does not appear to have been any industry research on the consequences of default from the client perspective.

The Smart Campaign is very interested in these topics, as are many practitioners we have been in touch with. Thus, this month, to kick-start a larger investigative project, CFI invited endorsers of the Smart Campaign to take part in a survey that asked MFIs about practices related to default. We believe that collection, analysis, and dialogue around such information can help the industry improve how it handles clients in arrears, and perhaps how to salvage, versus sever, relations with clients who have defaulted.

We posted approximately 20 questions on Survey Monkey and held our collective breath, anticipating a potentially low response rate, because the questions touched upon sensitive issues. We were pleasantly surprised, though, to receive more than 300 replies (198 from Anglophones, 59 from Francophones, and 74 from Spanish speakers). We are grateful to all who took the time to complete the survey, in particular those who went above and beyond the call of duty, like a practitioner in the DRC who wrote an essay on applicable microfinance laws and regulations.

Early Findings

The survey illustrated significant diversity in how MFIs deal with defaults, beginning with when collections procedures are triggered (for many, it coincides with the first missed payment), what form those collection efforts take (group pressure, taking individual or group savings, seizing collateral or guarantors’ assets, offering debt rescheduling/restructuring, or using the courts to collect overdue debts), and whether debt collection is outsourced (yes, in 29 percent of the respondent institutions).

One somewhat surprising result was that 27 percent of respondents treat default as a strict liability offense, meaning those borrowers who have defaulted due to illness or natural disaster are treated the same as those with perhaps less sympathetic motives – for example, losing money at cards or fraud. Spanish-speaking respondents were more likely than their Francophone and Anglophone peers to distinguish based on reason for default. For the majority of MFIs that do treat unintentional defaulters differently than those deemed to have intentionally failed to repay, steps for unintentional defaulters include giving more time, restructuring loans, granting bridge loans, and one MFI mentioned it may consider debt forgiveness.

It appears that the majority of the respondents offer restructuring options to clients who have defaulted.² However, a deeper analysis is required to understand at what point this option is offered (for example, after savings, collateral, or guarantors’ assets are seized, or before?), whether rescheduling is discretionary, and if a standard operating procedure exists, is it incorporated into staff training manuals and is it explained to clients.

The vast majority of MFI respondents continue to collect on debts after they have been written off as defaults, with some 85 percent indicating that they keep debt files open post write-off. About 40 percent keep client files for more than seven years. About a third of respondents maintain files on defaulting clients for one to three years. Thus, we are interested to see what ongoing actions if any MFIs take to collect debts over the years, and whether a country’s legal framework provides any guidance on how long debts are valid. For example, are there contractual time bars or prescriptions on the collection of debts beyond a number of years? Is there an existing credit bureau with related legislation?

Another issue we’d like to better understand is whether there are commonalities among MFIs in how they approach collateralization of loans. Almost 75 percent of respondent MFIs are taking collateral, and, nearly 92 percent of those polled responded that they have specific policies on what is acceptable as collateral. In some states, legislation dictates what is possible. Again, we’d like to know how the type of collateral, be it obligatory savings or physical assets, plays a role in a default. More importantly, is there a fair balance between protecting the MFI’s risk, and the risk to a client to lose these items and relationships in a default?

And, finally what socio-economic impact does the default have on the debtor and her family over time — particularly when collaterals are lost or guarantors must pay? Is it possible to re-integrate a defaultor into the financial services sector? Are MFIs likely to re-lend to someone who has defaulted and if so, under what terms? Or, is microfinance as it is practiced now a one strike and you’re out game?³

As you can imagine, the initial survey raised many more questions. We are excited to have the opportunity to explore this important issue, and fortunate that so many MFIs are interested to explore the unchartered waters of default and its implications for clients. Stay tuned for more on this subject from the Smart Campaign.

Jami Hubbard Solli began working on microfinance regulatory issues in 2005 when she joined the International Development Law Organization (IDLO). Jami established IDLO’s department on microfinance regulation and consumer protection. In 2011, Jami joined Consumers International, UK as a senior policy advisor on financial services consumer protection and access to justice issues. She is a member of the Smart Campaign’s Steering Committee, the International Bar Association, and the founder of the Global Alliance for Legal Aid (GALA) which supports access to justice for the poor in developing countries. 

Image credit: DSNews

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[1] Jessica Schicks, Over-Indebtedness of Microborrowers in Ghana: An Empirical Study from a Consumer Protection Perspective, Centre for EU Research in Microfinance, Nov. 2011. Available online at www.centerforfinancialinclusion.org publications.

[2] Almost 78 percent of the respondents offer restructuring, however, the question regarding how often restructuring had actually been done in the last year elicited a wide variety of responses from ‘one time’ to ’80 percent.’

[3] The author recognizes she needs to learn cricket terminology which may be more appropriate in an article on microfinance than using baseball terminology. In baseball, after three failed attempts at bat called ‘strikes,’ the player at bat has failed.