Microfinance Over-Indebtedness: Understanding its Drivers and Challenging the Common Myths

Analyzing over-indebtedness in microfinance
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This paper explores the definition, concept and causes of microfinance over-indebtedness.

The paper states that over-indebtedness is among the most serious risks of microfinance, and endangers social impact and stability of the industry. It analyzes existing definitions of over-indebtedness, and defines microfinance over-indebtedness in terms of sacrifice made by the customer to meet loan obligations. The paper reviews consumer finance literature and identifies key drivers of over-indebtedness. These include:

  • External influences such as economic shocks, natural disasters and regulatory environment;
  • Aspects of lender behavior, such as aggressive marketing and growth, products unsuitable to borrowers and weak lending procedures;
  • Aspects of borrower behavior, such as cognitive and psychological biases, sociological influences and demographic and economic factors.

The paper identifies and challenges five common beliefs regarding microfinance. These include universal benefits of competition, inappropriateness of consumer loans in microfinance, need for tight repayment schedules, irrational decision-making of the poor and need for MFIs to communicate Annual Percentage Rate to maintain transparency. The paper highlights the need to implement customer protection measures to reduce the risk of over-indebtedness.

About this Publication

By Schicks, J.