Elders Encounter Obstacles to Financial Security
By The Smart Campaign
The practice of microfinance boasts a considerable success rate when it comes to the rate of on-time loan repayment. But when clients do get into trouble, what actually happens to them?
New research finds that the fate of distressed borrowers depends less on the mercy of the institution to which they owe the money, and much more on the rules of the country where they live.
The Smart Campaign advocates for humane treatment of microfinance clients—including defaulters. Humane collections mean that lenders avoid humiliation tactics. They are flexible if possible, and they avoid depriving clients of the means of survival.
So to learn whether microfinance collections practices live out this ideal, researchers from the Smart Campaign decided to examine practices in three countries—Uganda, India and Peru.
CFI approached this research by recognizing both sides of the issue. Default pits the lender’s institutional survival against the plight of the defaulting customer, with high stakes on both sides. Consider the lender’s predicament. The loss of any single loan may be insignificant, but when word gets out that a lender is soft, mass default can quickly infect the whole portfolio.
The stakes may be even higher for the defaulter who often has landed in financial distress through a medical emergency or other crisis. Research in Ghana found that borrowers will skip meals, sell possessions or withdraw their children from school if they must to stay current on their loans. If borrowers who are still repaying make such sacrifices, defaulters have likely progressed to even more desperate measures.
CFI’s report found that the treatment of defaulting clients depends not so much on goodwill by individual lenders as on three characteristics of the local environment:
- Effective regulators
- A well-functioning credit bureau
- A culture that upholds fulfillment of debt obligations
When these features are weak or missing, even well-intentioned lenders feel pushed into harsh practices.
In Uganda, which lacks effective credit bureaus and government identity cards, borrowers often escape from collectors by running away or even changing names. Fearing borrower flight, lenders pounce as soon as a payment is missed because they know that if they wait, another creditor may get there first. So they seize collateral because they feel they have to—and because they can, since enforcement of due process is rare. Fear of such harsh tactics prompts borrowers to flee, and no consumer protection policies exist to halt the spiral.
The situation in India was less dire but repayment there depends, to a troubling degree, on public shaming. Unpaid debts are often public knowledge because the dominant credit model is the group loan, where lenders rely on group pressure to enforce repayment. If an entire group’s access to credit can be jeopardized by a single defaulter, it’s not hard to imagine the intense pressure neighbors can inflict on any distressed borrower.
The picture was dramatically better in Peru where there are competent regulators and clear rules barring harsh tactics. Debt collection proceeds privately, often starting with a telephone reminder. Peru also, critically, has effective credit bureaus, so borrowers strive to preserve good credit reports. Knowing how seriously borrowers take their good names gives lenders, in turn, the confidence to be more flexible.
In short, the Peruvian credit bureaus enable lenders to be humane. CFI’s findings make it clear how directly the customer experience is linked to a country’s financial infrastructure and its regulatory framework.
The Smart Campaign is a global effort to embed a set of client protection principles into the fabric of the microfinance industry. It is overseen by a broadly representative Steering Committee and staffed by the Center for Financial Inclusion at Accion.