For years the world has patted itself on the back about the rapid growth of Cambodia’s microfinance market. Over the past decade, Cambodia’s market has been one of the fastest-growing globally, recording a 127% portfolio increase between 2013 and 2014. Forty-five microfinance institutions (MFIs) now serve some 1.8 million borrowers, out of a total population of 15 million. In a country where the level of formal financial inclusion is negligible, this has looked like a notable success story.
However, as researchers have delved deeper, they have come across figures that cause concern. A study by the Institute of Development in 2013 identified Cambodian clients who have as many as six separate loans, while 51% of clients reported having made a sacrifice (such as eating less or poorer quality food) on at least one occasion in order to make a loan repayment. Competition for clients is intense, and borrowing from multiple sources is commonplace.
After the microfinance crises in India, Bosnia and Nicaragua, practitioners, regulators and investors are on the alert for an overheated microfinance market. But are reckless lenders pushing debt on to poor people who lack the knowledge they need to grasp the real risks?
If that is the case, it makes sense to heed calls for regulatory caps on the number of loans that each client might take out. After all, if multiple borrowing is leading to over-indebtedness – and borrowers are struggling with repayments – lenders are likely to employ harsh collection tactics to cover their liabilities (leaving their clients to default on someone else’s loan).
Tighter regulation can help to avoid the moral quandary of lending money that a client cannot afford to repay, if it takes into account the number of loans taken out by a client, and whether those loans are the right size given a client’s debt capacity.
But most Cambodian MFIs would argue that they already conduct rigorous loan appraisals. While this may not necessarily always be true, certainly many multiple borrowers are able to demonstrate their capacity to repay. In view of this, is multiple borrowing a problem in itself? Or is it symptomatic of a deeper (but different) market malaise? To answer this, first we need to understand what is happening at both the client and lender level.
Let’s consider, for example, that it is market failure that drives multiple lending. Why else would clients borrow from two different providers? Two explanations emerge: the first is over-indebtedness. Borrowers who are experiencing difficulties servicing one loan, might borrow elsewhere to stay afloat.
Equally, however, it could be be a rational response as they patch together financial solutions to meet their varied and unpredictable needs for lump sums. Where individual MFIs are over-cautious and limit risk by lending less than clients require, or where the market isn’t offering the right type of lump sums (which could be delivered through savings or insurance), in Cambodia, overstretched borrowers may default to taking more credit as new demands for cash arise, for example, following a health emergency.
The experience of one organisation, AMK, chronicled in our recent book, The Business of Doing Good, offers important insights. Since 2003, AMK has grown to become Cambodia’s market leader (in terms of client outreach), serving more than 360,000 clients in 80% of villages. Based on a profound understanding of the lives of rural Cambodians, AMK is notable for the uniqueness of its approach – especially when it comes to tackling complex challenge of avoiding over-indebtedness, and thinking what responsible lending means in a crowded marketplace.
For AMK, avoiding over-indebtedness starts with ensuring that it is offering the right product at the right time, so that clients are not left servicing a loan for a failed investment (a loan for fertiliser, for example, must be disbursed in time for the rains). Given the volatility and unpredictability of clients’ finances, a regular repayment schedule inevitably demands sacrifices when seasonal income drops, or unexpected costs arise. So flexibility is key. For AMK, this means a unique credit line product that allows clients to draw down what they need, when they need it, and repay when it makes most sense; as well as dropping penalties for early loan repayments. An emergency loan product is also available, to help clients cope with the unexpected. Lending decisions are always based on careful repayment capacity assessments. But given the reality of illness, accidents, crop failure and other unexpected demands on cash, what happens after a loan is approved also matters — a lot. This is why AMK uses a “soft collections” approach, working with clients who are willing, but unable, to repay, to find a solution to get them back on their feet.
The flip side of the "multiple lending coin" is "multiple borrowing", and of course, clients also bear responsibility for their decisions to take on debt. In the past, AMK sought to protect clients from bad decisions, and banned lending to Cambodians with outstanding loans from another source. Before the national credit bureau was set up, staff had relied on the honesty of borrowers (and their guarantors) to determine whether they had any other loans. When it opened, AMK found that around 20% of its clients were multiple borrowers.
The new data allowed the “one client, one loan” policy to be enforced more effectively. But, with increasing competition and five or six institutions often lending in the same village, the number of loan applications rejected has risen – often from repeat clients.
Now that they are familiar with credit, many Cambodians are more demanding. They are also able to pick and choose from lenders. How could AMK risk losing its clients or failure to grow in the name of avoiding over-indebtedness?
In response to this challenge, AMK has negotiated the difficult balance between institutional and clients’ needs. Instead of relaxing its multiple lending policy, management opted for “internal multiple lending” – reasoning that if a client needs more credit, it is much more preferable that they get it from AMK, with its strong commitment to client protection. This policy allows clients with a good track record to take an additional loan from AMK. Careful debt analysis enables AMK to distinguish between borrowers with a genuine need for additional capital, and those who may be struggling with existing debt.
Successful microfinance carefully balances its commercial and social motivations. Where concern arises around multiple lending and over-indebtedness, it is too simplistic to put it all down to profit-hungry MFIs recklessly lending to vulnerable clients who need regulatory protection.
Successful microfinance carefully balances its social and commercial motivations. Where concern arises around multiple lending and over-indebtedness, blaming profit-hungry MFIs, recklessly lending to vulnerable clients who need regulatory protection, is overly-simplistic. There are three key variables here. First, we need to know whether lenders are offering well-designed, well-managed, responsible products to the right clients. Secondly, in a buyer’s market, we need to respect clients’ right to make informed choices and support their capacity to do so. AMK recognises this as an important part of responsible lending, and is working with others to promote sector-level support for client financial capability. And finally, we need to recognise market imperfections and the risk of over-indebtedness, which is exacerbated by the ready availability of credit from multiple organisations. To balance the risks of short-term commercial interests leading to inappropriate lending, regulation is important. However, this should focus on ensuring that MFIs assess client capacity to repay and utilise credit bureau data on clients’ existing debt, rather than imposing arbitrary caps on numbers of loans.
This is the full version of an article that first appeared (in edited form) on the Guardian Development Professionals Financial Inclusion hub, under the title "Drowning in Debt?"