By Vivien Kappel, Annette Krauss and Laura Lontzek; published by Center for Microfinance and the University of Zurich, responsAbility Social Investments AG, Triodos Bank and Council of Microfinance Equity Funds; December 2010; 53 pages; available at:?http://www.triodos.com/downloads/276627/over-indebtedness-report-full-st…
This study attempts to provide a methodology for establishing an early warning index for over-indebtedness to aid in preventing future microfinance “crises.” Over-indebtedness is defined as the ?inability to repay all debts fully and on time…occurs if this situation occurs chronically, i.e. in several periods in a row, and against the borrowers? will?.
The rapid growth of microfinance in recent years has attracted new entrants into the sector. Thus some markets have become over-saturated with microfinance institutions (MFIs), resulting in clients taking on more debt than they can repay, often by borrowing from multiple MFIs. The issue of over-indebtedness is compounded by borrowing from informal lenders, a lack of credit bureaus and the aggressive growth policies of many MFIs.
Over-indebtedness can be both psychologically and socially detrimental to borrowers, as well as harming the relationship between borrowers and MFIs. Although it can be hard to measure, investors place great importance on over-indebtedness because it also lowers MFI portfolio quality. The authors contend that past over-indebtedness crises, including those in Bolivia (1999), Bosnia and Herzegovina (late 2008) and Morocco (late 2008), merit the creation of an over-indebtedness “early warning system.”
Using data from a survey of 119 MFIs; the relevant history of Bolivia, Bosnia and Herzegovina and Morocco; and further literature review, the authors identify ?leading indicators? that can signal forthcoming trouble. The 14 indicators include remittances per capita, market penetration, growth rate of total loan portfolio, quality and use of credit information systems, perceived commercial bank involvement, perceived levels and trends in competition, perceived investment flows, MFI liquidity and average loan balance per borrower.
These indicators are used to build a composite index called the ?Over-Indebtedness Early Warning Sign Index? (OID Index). The OID Index is scaled to a range of 1 (low levels of early warning signals for an over-indebtedness crisis) to 10.
The study applies the OID Index to a group of 13 countries. Bolivia, Ecuador, El Salvador and Georgia were found to have a relatively low OID Index score. Armenia, Paraguay and Tajikistan were found to have a medium score. Bosnia and Herzegovina, Cambodia and Peru have a relatively high OID Index score. The authors assert that the high score for Bosnia and Herzegovina is due to ongoing over-indebtedness lingering from the 2008 pinch. Cambodia?s score is interpreted to be the result of a lack of a functioning credit bureau. Peru?s relatively elevated risk is due to high scores for perceived levels of competition, commercial bank involvement and investment inflows, combined with a high level of liquidity in the industry and the relatively strong presence of multiple lending and consumer lending.
By Witt Gatchell, Research Associate
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