«Over-Indebtedness in Mexico: Its Effect on Borrowers Over-Indebtednessin Mexico: Its Effect on Borrowers Scott Graham, FINCA International Julia A. ...»
Over-Indebtedness in Mexico:
Its Effect on Borrowers
Its Effect on Borrowers
Scott Graham, FINCA International
Julia A. Ericksen, Temple University
Eugene P. Ericksen, Temple University
With special thanks for support from:
Summary and Main Findings
Signs of Trouble
Investigating the Problem in Mexico
Credit Bureau Data and Branch Manager Survey
Incidence of Debt and Arrears
Branch Manager Survey
Pathways to Debt: Client Interviews
Benefits from Micro-Credit
Borrowing for Emergencies
Borrowing to Consume
Borrowing for Others
Sink or Swim
Fuel on the Fire
Squeezed on All Sides
The Microfinance CEO Working Group requested this study in order to investigate the scale of over-indebtedness in Mexico andits root causes. The research was designed and executed by the authors in collaboration with FINCA staff, whose contribution we gratefully acknowledge. Data collection was supervised by Julian Diaz-Peralta and Katie Torrington.
Carol Gardner assisted with early drafts. We would like to thank Rupert Scofield, Soledad Gompf, Luis Camacho and BijanOsburgin particular for their support.
Summary and Main Findings
FINCA and our colleagues in the socially responsible lending community are anxious to avoid a debt crisis in Mexico, similar to those that have caused major upheavalsin other countries. We engaged with staff in our Mexican subsidiary to study this problem, with the aim of establishing some of its dimensions and uncovering the client pathways to debt.1Our research combined three methods: a review of credit bureau data from a pool of loan applicants, a survey of branch managers, and qualitative interviews with borrowers themselves, most of whom were experiencing or had experienced debt problems.
In the credit bureau data, we found a high prevalence of new FINCA applicants having existingloans (about 74 percent), many of these with multiple accounts in arrears. Fully 60 percent of those with two outstanding loans were found to be in arrears, with the number rising to 80 percent of those with four sources of credit. Reflecting this situation, branch managers report that it is increasingly difficult to find qualified borrowers – people whose existing debt burdens would not impair their ability to repay new loans. They also paint the picture of a highly competitive and growth-drivenmarketplace in which bad practices are commonplace, such as credit promoters disseminating false information about rival lenders, giving incentives to clients for agreeing to loans on the spot, and even delaying credit reports so that a paid-up client is unable to obtain credit elsewhere. Managers also report that most borrowers have little understanding about the actual terms of their existing loans.
Our discussions with borrowers unveiled various pathways to over-indebtedness, none of which are new. Lacking savings or other assets, our interviewees use credit to financea wide variety of productive pursuits and to deal with family contingencies, such as the death of a family member or a medical emergency. At the same time, they are pressured to help The Working Group also commissioned a companion piece, Over-indebtedness: A Risk-Management Approach, which is discussed later in this paper.
out needy members of the extended family. Passing along loan proceeds to a relative who does not qualify for credit, they are left to deal with the consequences when the money goes unpaid. While some borrowers readily admitted that they were tempted to live beyond their means, most of the purchases, such as school uniforms, could hardly be considered extravagant.
Regardless of what had gotten them into trouble, the over-stretched borrowers we interviewed were determined to settle their accounts with their creditors and were making every effort to do so, even when they felt that they had been taken advantage of. Rather than walk away from their obligations, they were doing what they could to pay off their loans, perceiving that continued access to credit will continue to be important for their future endeavors. This behavior extends to the members of peer lending groups, who go so far as to absorb the debts of defaulting members in order to continue accessing credit.
If profligate behavior is leading to a crisis of over-indebtedness, then, it is on the part of lenders. Spurred in partby the relaxation of oversight in 2006, the number and variety of creditors, along with the total volume of loans, have increased massively.2 It is safe to assume that most lenders are profiting under current conditions. On one hand, we find a vast pool of potential borrowers who have very pressing needs for money, and who will go to great lengths to settle their debts. On the other, an eager throng ofcreditors, both commercial and non-profit, willing to make loans with little regard for the borrower’s financial situation. An institution with proper credit discipline would avoid making risky loans because of the costs they incur, including written-off principal, lost income, and extra administration. But in Mexico, creditors are successfully pushing the costs of their reckless loans onto the borrowers themselves. With customers paying the price, bad lending seems to be good business – for the time being, at least.
To avoid a likely crisis, lenders ought to act voluntarily and soon. They should curb their appetite for unrestrained growth in favor of a more sustainable approach, one that is concerned withthe needs and capacity of their customers and with building a high-quality loan portfolio on the basis of sound credit discipline. Rather than proliferate bad loans at the borrower’s expense, lenders (both for-profit and non-profitalike)shouldmake a clear statement of honest intent by publicly committing to the Client Protection Principles as articulated by the Smart Campaign, and submitting to external verification of their compliance.3In shifting the focus from growth to quality, lenders will also need to review We refer to the changes in banking legislation which created a new type of lending entity in Mexico, called the SociedadFinanciera de ObjectoMúltiple, or SOFOM. An unregulated SOFOM does not have to report to the National Banking and Securities Commission, nor does it have capital or reserve requirements.
The Smart Campaign promotes a self-assessment by lenders, as well as an external certification process whereby lenders can gain an independent verification of their adherence to the Client Protection Principles.
the internal incentives that are propelling both staff and clients towards irresponsible credit decisions.
Sustainable lending beginswith a careful assessment of a prospective borrower’s financial situation – including his or her family circumstances– prior to approving a loan. At the same time, the lender should ensure that the borrower fully understands both the loan terms and its impact on her cash flow. Given that this cash flow is often irregular, especially for self-employed individuals, some measure of flexibility would help to match the borrower’s obligations with her capacity to repay. This is especially true when a borrower is under duress, and finds herself driven to migrate from creditor to creditor in order to avoid default.
This course of action can be pursued by any lender that is seriously committed to the welfare of its clients. However, it is important for these changes to be implemented by a broad range of creditors, including both for-profit and non-profit institutions. Sociallyresponsible microfinance institutions (MFIs) might implement the Client Protection Principles, but what about retail creditors and payday lenders? Therefore, in addition to the voluntary actions by lenders, it is important for regulators to step-in to protect the public’s interest in a financial system that is sustainable, inclusive, and that enhances rather than weakens the economic prospects of the poor.
We are not experts in banking regulation and therefore leave the specifics of this recommendation for debate by others who know the topic well, and who can draw from the positive and negative experiences of other countries, such as India and Nicaragua, where over-indebtedness has spurred government action. Official intervention is powerful and should not come at the cost of financial inclusion. But the experiences of our interviewees suggest that there is significant scope for elevating the government’s role in a number of areas, including educating the public, providing means for redress, and ensuring that credit providers adhere to minimum standards of credit discipline.The strengthening of credit discipline, in particular, seems all the more urgent in light of recent legislation which is likely to considerably accelerate the flow of credit to the low-income sector.4In the absence of such measures, borrowers – especially those whose lives are precarious to begin with – are exposed to the whims of a growing market that not only fails to deliver on the promise of financial inclusion, but which actually makes their climb out of poverty even steeper.
Over-indebtedness occurs when a borrower has more debt than he or she can reasonably repay, given income, savings and assets. As the sheer volume and varying forms of credit are increasing in Mexico and other countries, there is evidence that over-indebtedness poses a substantial challenge for lenders and borrowers alike. Debt repayments start to consume a disproportionate share of borrowers’ available resources,leading toarrears, additional collection costs and high default rates. For regulated institutions, a deteriorating portfolio can trigger higher reserve and provisioning requirements, straining their solvency. Given such consequences, it is no surprise that a 2012 survey of more than 350 microfinance practitioners and analysts from 79 countries revealed that over-indebtedness was the number one concern.5 As bad as the situation can be for lenders, the consequences of over-indebtedness are typically devastating for individuals and families, who are often already poor, or nearly so.
Faced with spiraling debt, exorbitant penalties and sometimes heavy-handed collection practices, over-stretched borrowers may feel they have little recourse except to refinance their debt with even more loans, or to liquidate their personal and business assets. The economic pressure puts additional strain on the extended family and can even pit neighbor against neighborwhen group guarantorsare forced to absorb the debt of a defaulting member. For mission-driven MFIs, the possibility of pushing clients deeper into poverty and unraveling their support systems raises very troubling prospects.
Surprisingly, given these consequences, there is not a lot of research that explores the underlying causes of over-indebtedness. Lenders are naturally aware of growing competition, and stories quickly circulate about distressed customers or borrowers who feel they were deliberately misled by credit providers eager to make a loan. But there are two parties to every loan agreement, and every over-stretched borrower has a unique set of circumstances and decisions that led to her current state. We feel that a systematic investigation into the different ways that credit problems manifest in the lives of debtors and their families could yield some useful insights, or at least allow us to consider possible solutions from the viewpoint of the people most affected – the borrowers themselves.
Microfinance Banana Skins 2012, the CSFI survey of microfinance risk, Staying Relevant (UK: Centre for the Study of
Financial Innovation), p. 7. Accessed 10/21/13 at:
Signs of Trouble FINCA currently serves 136,000 low-income people in Mexico with small individual loans, village bank loans and insurance, with a loan portfolio worth $47 million. Since 2012, FINCA’s managers have noticed a troubling trend: increasing over-indebtedness among potential clients. While credit officers are still able to find new loan applicants, it is becoming increasingly difficult to find new customers who don’t already have several outstanding lines of credit, or who aren’t behind in their payments on their existing debt, especially in certain regions.
At the same time, the Microfinance CEO Working Group6 – a collaborative effort of microfinance leaders working to create positive development for the industry – hasbeen tracking markets worldwide for risk factors. Mexico deserves special attention because it has exhibited an enormous increase in consumer lending, not just among microfinance institutions and commercial banks, but also payday lenders, pawn shops, and retailers. As early as 2007, Business Week noted that in Mexico, “even Walmart has a banking license.”7New players aren’t the only ones fueling this growth. Credit cards are proliferating, and banks have increased lending limits for many customers. According to Euromonitor, a financial strategy researcher, payday loans alone increased by 100 percent in 2012.8 Further, since enabling legal changes in 2006, Mexico has gained more than 3,000 unregulated credit providers, registered as a Multi-purpose Financial Associations (SociedadFinanciera de ObjectoMúltiple, or SOFOM in Spanish), whose lending activities are not subject to banking oversight.