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> Posted by Elisabeth Rhyne, Managing Director, CFI

The following post was originally published on the CGAP Blog.

Gabriel Davel knows what he’s talking about, and so should you. Davel is the veteran bank regulator who helped create and lead South Africa’s National Credit Regulator, one of the most capable financial consumer protection agencies in the world. In CGAP’s new Focus Note, Regulatory Options to Curb Debt Stress, Davel draws on the experience of a number of debt crises in microfinance and consumer credit and distills his own hard-won experience into practical guidance aimed mainly at regulators, but also highly relevant for financial institutions.

A perennially intriguing – and urgent – question is how regulators can tell when a crisis of reckless lending and over-indebtedness is on its way. Before a crisis hits, everyone has interests in credit expansion: individuals want loans, lenders want to grow their client base and loan portfolios, and governments want credit expansion, especially for previously excluded clients. But at some point, the bubble over-inflates, highly-leveraged clients are living precariously, and even a modest economic shock can trigger the inevitable collapse. Davel recounts 11 such incidents in microfinance and consumer finance. In their book, This Time is Different, on banking panics, Reinhart and Rogoff document not dozens but hundreds of similar crises throughout history. Their point? It is never different. Credit markets fool themselves time after time.

Is there any way for financial sector participants, happily tipsy from an expansion of credit, to recognize when they need to slow down? Does it take a restrictive set of credit rules? What are the secrets to responsible credit?

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