In the past few months, the Indian microfinance industry has learned that not all publicity is good publicity. A few Kiva Fellows wanted to learn what the issues were, and what can be done to prevent them in the future. We will present our findings in a series of blog postings over the coming days. Given the inherent complexities, the multiple viewpoints and an ever changing political and legal landscape, our work is only intended to provide a top-level summary of the situation as it stands now. If you are interested in learning more about microfinance in India, we encourage you to explore these issues beyond what is presented, and to draw your own conclusion.
This is the third in a series of four posts. The first two can be found here:
Evaluating capacity to repay
About a month ago, it seemed like all I heard about was clients’ who were denied loans, or who got loans significantly smaller than what they needed. At the time, I was concerned about how many people weren’t getting the finances they asked for. Then I heard about the suicides in India and was glad to know that the Kiva partner where I’m stationed, ACCION Texas-Louisiana, carefully considers how much to lend each client.
It’s an issue every Microfinance Organization has to take seriously. Kiva Fellow Julia Kastner gave a few examples of why loan size matters in an earlier blog post. I think Kiva Fellow Carlos Cruz Montano in Paraguay puts it well; “It’s in the best interest of the microfinance institution that their clients are not overindebted – it is their objective to improve members’ standard of living.” Not only does overindebtedness put the organization’s investment at risk, it also goes against their primary goal. Carlos goes on to say “In Paraguay there is a credit bureau that all banks/MFIs report to and I believe Fundación Paraguaya is well protected against borrowers with too much debt.”
Here in the US, ACCION has access to a lot of formalized systems to help with determining who to lend to, and how much. They look at the applicant’s credit score, as reported by TransUnion (a formal Credit Bureau). They request official pay stubs, tax forms, bank statements, and other documentation to verify the applicant’s capacity to repay. For collateral, they look at titles, leans, insurance, sales receipts, tax appraisals, and other legal documents, as well as doing an in-person inspection. And they require a business plan and other documentation about the applicant’s business. Not all of these documents are required for smaller loans. But in order to get more than $5,000, the client has to prove their capacity to repay.
The process works similarly in other countries, even when these formal systems are not available.
For example, CRAN in Cape Cost, Ghana, relies much more on education, the borrower, and their co-borrowers to determine a good loan size. Kiva Fellow Jacqueline Gunn explains:
“The loan product itself is Credit with Education. Each client undergoes a five week training course to understand the process, the expectations of the individuals and the responsibilities of the solidarity group. This training means that they often ask for a loan of appropriate size from the beginning.
The structure of the solidarity group is key. During the approval process, both the loan officer and the other 4-5 members of the group are involved. The loan officer interviews the applicant about their business. They conduct an assessment in person to evaluate the potential for income generation. The group also assesses their fellow solidarity group members’ businesses to make sure they are happy that the loan is an appropriate size.”
The Loan Officer Jacqueline spoke with said
“I don’t want my clients lying in bed at night worrying for me to come and visit to get more money, it will ruin their life.”
And in Rwanda, this is how it works, according to Kiva Fellow Caitlin Ross:
“Amasezerano’s (ACB’s) main way to make sure that clients can repay their loans is a thorough analysis of their businesses, cash flow, and collateral to make sure they can make their payments.
For salaried individuals, they have certain systems in place; for example, an individual can take out a limit of 8 times his/her monthly salary. However, if he/she takes out a loan of 8 times his/her salary, the repayment period is automatically set at 24 months (as opposed to 4, 12, etc), lowering the monthly repayment amount and spreading it out over time, so (s)he isn’t giving too much of his/her salary to the repayment process each month. It’s set up like this so, theoretically, the client will always have enough to live on while still making monthly payments.”
Pressure to lend
As Abhishek wrote earlier in this series, the explosive growth of microfinance in India was one of the major causes of the current problems there. The key is to grow without losing sight of the social agenda of the organization. Back in the US, ACCION Texas-Louisiana does this by offering business education, and has set up employee incentives to mitigate the risk. But ACCION is also growing quickly, and intends to continue doing so.
ACCION Texas-Louisiana is a not-for profit, but they still focus a great deal on growing their loan portfolio. The biggest reflection of this is the Loan officers’ loan disbursal goal. If they don’t meet their goal for enough months in a row, they lose their job.
However, Loan Officers also are given incentives not to make bad loans. They lose their commission if their active loan portfolio has too high a delinquency or default rate. Besides, they don’t get to decide whether an applicant qualifies for a loan, or for how much; Underwriting does. Underwriting is separate from the loan officers, has rigorous guidelines, and uses an automated system to do a first pass evaluation on applications. They’re also not paid based on how many loans they approve, which would be an obvious conflict of interest. As the CAO told me
“At the end of the day, if we don’t think the loan will help an applicant, we don’t want to give it to them… we don’t want to give them just more debt.”
Fundación Paraguaya is also balancing growth with careful internal incentives. According to Kiva Fellow Carlos Cruz Montano:
“Microfinance is growing fast in the country and until recently they were the only institution offering loans with no collateral to poor women. Fundación Paraguaya is responsible for its own decisions, meaning that if they are not competitive or interests are above market levels, other institutions will take their customers…
Loan officers’ incentives take into account the number of delinquent loans…. Incentives are based on a number of categories. Between them are size of portfolio, new loans, and delinquent loans. Other measures are tied to institutional objectives.”
Pressure to repay
Going back to the issues in India; would these problems occur if there was no expectation they repay their loans? Probably not. But then no loans could happen in the first place; even clearly beneficial ones.
For most of my fellowship, I sat across the cubical wall from the collections department at ACCION. All day, I could hear them calling individuals who were delinquent on their loans. They were always respectful, but also clear and direct. Sometimes I heard them offering to restructure the repayment schedule so the individual could still repay it. Mostly I heard them trying to contact clients, explaining the situation, and asking for details from the clients.
Different partners handle delinquencies and defaults in different ways. Various Kiva Fellows have already written about aspects of this, such as how some loan officers use social pressure to collect on loans, what the job of a debt collector is like, and how one lending group handled the delinquency of one of its members.
For group loans, it’s important to remember that pressure to repay comes not just from the microfinance institution, but from the rest of the group as well. Kiva Fellow Caitlin Ross describes how Amasezerano’s (ACB’s) in Rwanda prepares for that:
“For solidarity groups, ACB makes sure that the members of the group have a contract in place amongst themselves as to what they will do if a member defaults on his/her payments, such as; if a member misses a few payment, and another member pays for him/her, then the member who missed a payment might give the member who paid for him/her one of his/her cows for compensation. The credit officer is very involved while the group members are making this contract amongst themselves, to make sure the processes are understood, as are the consequences for missing payments. So while collateral is not required by ACB when giving credit to solidarity groups, a contract amongst the group members themselves laying out a process for missed payments is a requirement.”
These are examples of what is happening in debt collection. The challenge is to show that usurious collection practices or physical coercion are not. And that requires external oversight.
To learn about oversight and regulations from external agencies, tune in on Tuesday for the next installment in this series: “What is the industry doing to protect borrowers?”
Bridget Lewis is a Kiva Fellow at ACCION Texas-Louisiana in San Antonio, Texas.
Want to volunteer with the Kiva Fellows Program? Learn more here and apply to be a Fellow!