Multiple Borrowing: MicroPonzi Scheme, Underfunded Entrepreneurs or Understudied Topic?

As a few bloggers have mentioned, last week the Centre for Micro Finance and the College of Agricultural Banking held a conference in Pune with a focus on microfinance research results and implications for practitioners and policymakers. One of the research presentations, put forth by Prof. Rajalaxmi Kamath of IIM-Bangalore, engaged with the fascinating topic of multiple borrowing amongst MFI clients (a Powerpoint of her presentation will be online soon).

Derived from her field study which used financial diaries to track the cash inflows/outflows of MFI clients, Kamath's research showed that nearly all of the tracked households were indebted to multiple MFIs/SHGs (her sample size was approximately 20 households). As microfinance does not adhere to traditional banking’s credit rating/history infrastructure, nor do MFIs typically share client information with each other, the true extent of multiple borrowing must be ferreted out through informal means such as Kamath’s study. (A CMF study in 2007 tracked the extent of multiple borrowing amongst seven ICICI-partner MFIs through a database, but availability of such comparative data is rare)

Why would microfinance clients take out multiple loans? Potential causes might include a mismatch between the size of the loan and the business/personal needs of the clients, a lack of financial savvy, an abundance of financial savvy (aka ability to game the system) or the vacuum of oversight, among many other reasons. Kamath also found that there was some evidence of debt recycling, wherein loans were used to pay off preexisting debt and not for “productive purposes.” Furthermore, she believed that such debt recycling contributes to the phenomenally high repayment rates and excellent portfolio qualities of MFIs.

Could MFIs elicit this kind of credit information for their own records? The sector has in fact developed a number of tools, such as Microfinance Opportunities: Listening to Clients modules and the AIMS/SEEP Tools on Client Assessment, which produce financial snapshots of clients before and after receiving financial products. However, many microfinance institutions do not have the time, the will, nor the manpower to administer these tools. Additionally, I wonder what the incentives of NBFCs, funded by commercial debt (and possibly equity), are to further investigate multiple borrowing if JLG-driven credit continues to produce such low PARs and default rates? What are their incentives to engage with the infrastructure of a credit bureau if it will demonstrate the widespread nature multiple borrowing and raise eyebrows?

Professor Kamath's work raised a number of questions/internal dialogues for me:

- If multiple borrowing reflects underfunded entrepreneurs, would larger loan sizes result in less multiple borrowing, higher client productivity and greater financial/social impact? (Kamath mentioned the steep opportunity cost of client running from repayment meeting to repayment meeting) Yet, an “appropriately sized”(meaning one that matches the business needs of the client) loan might mean more operational costs in terms of a credit assessment by a loan officer. And, larger loan sizes might not be sustained in the joint liability model, dampening the sure-fire repayment rates and lessening the portfolio quality/appeal to investors of the microfinance sector.

- Are clients who take out multiple loans better off at the end of the day? Evidence from Bangladesh suggests that with BRAC clients from a certain district, repayment rates drop to 50% for households with loans from three or more MFIs. But is default really a bad thing for the individual client, given that loans are collateral-free and vouched for by JLG members, or simply for the MFI (or other members of the JLG)? Are some of these clients just engaged in a micro-Ponzi scheme? Or do the multiple loans ensnare them in a ceaseless merry-go-round of recycled credit from which they can scarcely augment their long-term standards of living?

- Finally, if NBFCs are not incentivized to investigate/mitigate against multiple borrowing, who should bring oversight?

I’m not sure of the answers to any of these questions but either way this was a thought-provoking study which I hope generates more research. Any comments/thoughts?

Sources: Presentation by Rajalaxmi Kamath at CMF/CAB Conference. "Microfinance in India: Small, Ostensibly Rigid and Safe." January 17th 2009