Author: Daniel Rozas.
Consider this remarkable chart. It’s a rare testament of human progress, showing a 10x decline in traffic deaths alongside a 10x increase in driving – one could be forgiven for thinking that the more people drive, the fewer traffic deaths they’re likely to cause! Of course, nothing can be further from the truth. Behind this chart lies 100 years of evolution in traffic safety.
In 1900, you could drive a car the way you drive a bicycle today – assuming you could afford one, you got in and drove, using roads built for pedestrians and carriages. Road signs, speed limits, traffic signals – all arose during the next several decades. In UK, a system for testing and licensing drivers was put in place only in 1935. Safety devices followed later still, with seatbelts becoming common (and eventually mandatory) only in the 1960s, and airbags only towards the end of the century. In short, it was a century of continuous evolution.
There is an interesting pattern in this very brief history – the initial decades dealt mostly with prevention, with the goal of reducing traffic accidents themselves. Mitigation efforts like seatbelts and airbags – which explicitly accept that accidents will happen and focus on making them less deadly – these took decades longer. Perhaps this is the natural course of things: mitigation requires the years of experience and humility to accept that not everything is preventable.
When it comes to overindebtedness, this is where our sector’s client protection practices are today – stuck in the era of prevention, with not even the bare minimum when it comes to mitigation. As credit continues to expand, the inadequacies of the current system will become ever starker, with the entire system of client protection losing credibility in the process. And the only way to preserve and rebuild that credibility is to develop serious and effective measures to mitigate overindebtedness.
A brief history of client protection in financial inclusion
Today’s client protection standards in the sector are administered by CERISE+SPTF, which picked up the work from the Smart Campaign when it closed in 2020. The Smart Campaign first formulated the standards when it launched in 2009, but in fact their history goes back further still.
The current client protection standards originated in a now-forgotten paper, lost to the dark ages of the digital era. For you won’t find this paper anywhere – I had to ask the author, Elisabeth Rhyne, who in Aug 2003 published “Taking Stock: Consumer Protection in Microfinance – A Non-Regulatory Approach.” The paper itself was in response to a then-new initiative by the SEEP Network to form a consumer protection task force. Hailing this effort, Rhyne proposed an interesting set of principles, presented below, alongside today’s client protection standards.
Elisabeth Rhyne, 2003 | CERISE+SPTF, 2024 |
1. Transparent pricing. This institution will give clients complete and understandable information about the true costs they are paying for loans and transaction services and how much they are receiving for savings. 2. Over-indebtedness. This institution will not lend any client more than the client can afford to repay. To do so creates a debt trap for clients, ruins their credit history, or worse. 3. Inappropriate collection practices. In collecting debts, this institution will treat clients with dignity and will not deprive clients of their basic survival capacity as a result of loan repayment. 4. Fair pricing. This institution will price its services at a fair rates. Its rates will not provide excessive profits, but will be sufficient to ensure that the business can survive and grow to reach more people. 5. Privacy. This institution will protect the private information of clients from reaching others who are not legally authorized to see it. | 1. Appropriate Product Design and Delivery. The provider's products, services, and channels benefit clients. 2. Prevention of Over-indebtedness. The provider does not over-indebt clients. 3. Transparency. The provider gives clients clear and timely information to support client decision making. 4. Responsible Pricing. The provider sets prices responsibly. 5. Fair and respectful treatment of clients. The provider enforces fair and respectful treatment of clients. 6. Privacy of client data. The provider secures client data and informs clients about their data rights. 7. Mechanisms for complaints resolution. The provider receives and resolves client complaints. 8. Governance & HR. The governance and management are committed to Client Protection, and HR systems support its implementation. |
The order and wording are different, and the standards have grown to eight from the original five. Most notably, only one standard – Rhyne’s Inappropriate Collection Practices – seems to have disappeared. In fact it hasn’t, but has instead been subsumed into Fair and Respectful Treatment of Clients. This is the first warning that something has gone deeply wrong.
Protecting clients from overindebtedness: 2024 version
Prevention of overindebtedness is self-evident – lenders are expected to exercise care when lending, making sure that their clients have the capacity to repay. This is the standard that’s worked remarkably well over the years, creating the expectation that all lending must be done on the basis of a full analysis of the client’s cashflows, and placing guarantees – whether through collateral, group liability or 3rd party guarantors – as a complementary risk mitigant, but never the primary one. Simply put, no matter what guarantee is provided, all lending must be predicated on first establishing the client’s income and ensuring that that income is sufficient to repay the loan. Moreover, the principle of overindebtedness prevention hasn’t stopped at assessing incomes, but assessing expenses too, which in turn has led the establishment or expansion of credit bureaus in dozens of countries – giving lenders the means of knowing what other debts (and hence repayment obligations) loan applicants already have.
None of this is perfect, there are informal debts that don’t make it to the credit bureau, unrecorded expenses that are outside the norm, inflated incomes and much else. But when lenders take this process seriously, they absolutely can and do typically avoid lending to those who cannot afford it. And the fact that this is done for farmers, small traders and others in the informal economy is a remarkable achievement. We should, as a sector, take credit for building out the capability to prevent overindebtedness that largely didn’t exist 20 years ago – a capability that’s every bit as good as what banks in high-income countries do when reviewing prospective borrowers’ salaries and tax statements.
But when it comes to mitigation, today’s client protection standards quickly fall short. Recall the one standard that seems to have gone missing? In Rhyne’s 2003 version one standard was clearly focused on mitigation: Inappropriate collection practices. In collecting debts, this institution will treat clients with dignity and will not deprive clients of their basic survival capacity as a result of loan repayment.
Here’s the full description of this standard today:
CP5. Fair and respectful treatment of clients The provider enforces fair and respectful treatment of clients.
ESSENTIAL PRACTICES
|
In the 2003 version, this standard had two parts:
1) this institution will treat clients with dignity.
2) the institution will not deprive clients of their basic survival capacity as a result of loan repayment.
In the 2024 version, part one of the standard has been substantially expanded, adding admonitions against abuse, requirements for a code of conduct and much else – most of which can be summarized as don’t threaten and don’t be rude.
But part two of the standard, the one that actually deals with mitigation (i.e. ensuring that clients won’t lose basic survival capacity) – this is gone. It’s true that in the full Client Protection Standards manual, you will find the following entry, listed as the very last indicator for this standard: 5.4.2. The provider restructures or writes off loans on an exceptional basis, based on a list of cases of specific distress. But this is far narrower than the original wording and is missing its core mitigating element – that whatever else happens, clients should not be forced into destitution in order to repay their loans.
And where has this brought us? The 2024 Financial Inclusion Compass asked contributors to rank the three areas of client protection that have the biggest weaknesses and demand the highest priority from the sector. Responses from nearly 150 industry actors, many of them long-time leaders in the sector, perfectly illustrate the problem:
Prevention of Overindebtedness is first – by a wide margin. Fair & Respectful Treatment of Clients is dead last.
Mitigation is now at best an afterthought, a weakly worded idea within the last indicator of the least valued standard. This is where the evolution – or in this case, devolution – of client protection has led to.
It’s as if we don’t believe in seatbelts.
Why is mitigation last?
To be clear, the lack of focus on mitigation is not a recent development. It had already been abandoned by the time of the 2011 version of the Smart Campaign Principles. And perhaps it’s not surprising – mitigation in our sector is so difficult that we’ve barely tried.
First, because mitigation comes up against another core tenet in our sector – the idea of repayment culture, that borrowers should always honor their debts and that any loosening of those repayment expectations will undermine borrower behavior. Hence the intrinsic tension and reluctance to delve into mitigation strategies.
Second, our social performance monitoring frameworks – which include client protection – are very data driven. Normally this is a strength, but in this case it’s a weakness. Whether drawn from surveys or administrative data, we measure everything in percentages. If some measure of client outcomes changes by less than 0.5%, it becomes a rounding error. To see why this is a problem, consider that the highest traffic fatality in the world is in Zimbabwe, at 41 per 100,000 inhabitants, or 0.041%. If Zimbabwe were to cut the rate in half, closer to the global average of 0.017%, it would be a spectacular achievement. But in our sector, it would be a change from one rounding error to another rounding error. Nobody would notice. We simply don’t have a reliable way to measure rare but severe bad outcomes in our sector – the very outcomes that would most benefit from mitigation. And as the dictum goes, what goes unmeasured gets ignored.
Finally, mitigation is inherently unattractive as an idea. Clients struggling with overindebtedness are usually dealing with financial hardships that go well beyond just their loans. Mitigating the debt stress faced by a client facing deep financial hardship should certainly increase resilience, but it doesn’t mean that they will spring right back to where they were. Oftentimes, all mitigation can do is help make a terrible situation slightly less bad – extremely valuable, but hardly inspiring. Nobody will ever put the face of a slightly less distraught client on the cover of a social performance report.
Taking these three factors – tension with repayment culture, absence of relevant metrics, and no easy way to communicate success – it’s no surprise that mitigation goes so often ignored. It’s just that much easier to direct efforts to something else – like prevention.
Is mitigation really needed?
If you read any of the articles about overindebted clients selling their family homes, putting their kids to work, or the even more tragic cases of suicide – the question isn’t primarily about how or why they received their loans, but the distress they experience when finding themselves unable to repay. It’s true that some of those cases involve clients who got loans that they couldn’t afford in the first place, which is to say, failures of prevention. However, most situations of overindebtedness happen after disbursement, sparked by health shocks, business setbacks, or other crises that are a constant threat to poor households. Simply put, not all overindebtedness can be prevented.
Moreover, the most prominent critiques of microfinance focus on aggressive collections – whether through harassing clients, pushing them to sell their assets or threatening them with all kinds of consequences if they don’t repay. But in doing so, they miss the deeper problem – an overindebted client simply has very few options. A friendly and respectful field officer who regularly visits a struggling client is effectively presenting her with a dilemma: make extreme sacrifices to repay or accept the shame of default. The power of this dilemma is hard to overstate – as one client put it during one of my recent assignments: “It is embarrassing. Death is better!”
Changing collections by focusing on staff behavior is a band-aid. What’s needed is a serious focus on mitigation.
What might mitigating overindebtedness look like?
Mitigation is very much possible. Nearly all high-income countries have some type of bankruptcy process that allows overindebted borrowers to find a path out. Such systems are possible in lower-income countries too. Indeed, back when SEEP was forming its consumer protection task force, South Africa was drafting legislation that explicitly focused on mitigating the effects of too much debt, passing the National Credit Act in 2005 that included not only a formal designation of over-indebtedness, but also established the function of debt counselling, through certified debt counsellors who can act on a borrower’s behalf in order to assess over-indebtedness and to renegotiate loan terms with lenders. The system remains in effect to this day, and, while not perfect, acts as an important mitigant for overindebted borrowers. All this was done without undermining the credit market in South Africa, which remains very much alive and well.
South Africa is a rare case in the sector, since the entire mitigation system is enshrined in law. But mitigation can start much more simply – MFIs in Bolivia, Ecuador and other South American markets regularly offer struggling clients to reschedule or restructure their loans in response to specific individual circumstances. And this isn’t simply a holdover from the pandemic. Out of 30 Bolivian MFIs in 2019 (i.e. pre-COVID), all but two had restructured some of their loans, with the median of 4.5% of their total portfolio reported as restructured. And the restructurings appear to have been effective – the quality of this restructured portfolio was only slightly worse than other loans – a median PAR30 of 3.5% vs. 1.8% for the total portfolio.[1]
The Bolivian MFIs give an idea of what can be implemented by a single institution and what metrics one could use to monitor both scale and effectiveness. But this is only a start – the data doesn’t distinguish between one-month extensions and long-term restructurings or between automatic postponements in response to natural disasters and responses tailored to specific client situations. Other questions arise also – how should rescheduled loans be reported to credit bureaus, and what sort of provisioning should they require? What about the role of collateral sales – when are these appropriate and how should they be monitored? And what about borrowers who have loans with multiple lenders at the same time? In truth, the degree of development and sophistication of mitigation techniques is at least a decade behind prevention ones.
Call to action and the road ahead
The time has come to rethink how the Client Protection Standards should approach overindebtedness.
Mitigation cannot be consigned to its ignoble place as the last indicator of a broad standard dealing with entirely unrelated issues, such as non-discrimination. Instead, it needs to be raised to the level of full standard: Prevention and Mitigation of Overindebtedness. This would recognize the necessity and complementarity of the two approaches – as with cars, both speed limits and seatbelts are needed.
Alongside this, new techniques and practices need to be developed to ensure effective mitigation, drawing on experiences in countries like South Africa and Bolivia – practices that should then be enshrined in a suite of indicators specifically focused on ensuring that mitigation is done properly.
It’s not the place here to design and describe the entirety of what those practices and indicators ought to be. That will require a multi-year and multi-country effort of gathering existing practices, piloting new ones, and developing new tools for monitoring implementation and measuring effectiveness. However, in pursuing this, it’s worth keeping some guiding principles in mind, three ideas that, in a nod to the original Smart campaign, can be referred to as the SMA:
Sustainability: a system of mitigation must be sustainable for all actors – the clients of course, but also financial providers, regulators, and others needed to sustain it for the long-term.
Measurability: mitigation requires its own set of standardized metrics to both monitor its implementation and measure its effectiveness at reducing debt stress.
Agency: any decision to request or accept a mitigation solution must be taken by a fully informed client. Like borrowing itself, mitigation may need approval (by the FSP or outside entity), but the decision to proceed should be left entirely up to the client.
Client protection has come a long way in our sector, and the very real accomplishments in the prevention of overindebtedness warrant recognition and celebration. But this is no longer enough. Our sector stands at an inflection point – either we choose to recognize the glaring inadequacy in overindebtedness mitigation or we run the risk of losing the credibility of the entire client protection system.
Let’s not be the car industry that refused to install seatbelts for decades, until it was finally forced to do so. We can and must do better.
About the Author:
Daniel Rozas is a Senior Microfinance Expert at e-MFP and a consultant and researcher on a broad range of topics. Daniel is also co-founder of the MIMOSA project, which provides a methodological assessment of market saturation and risk of overindebtedness for leading microfinance markets. Prior to his microfinance career, Daniel worked for the US mortgage investment company Fannie Mae during 2001-08, where he had first-hand experience with the extraordinary boom-and-bust cycle that took place in the US mortgage market during this period.
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