Principle #2 – Prevention of

Over-indebtednessThis presentation is made possible by the

Smart Campaign

www.smartcampaign.org

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1. Client protection principles2. Principle #2 in practice3. Participant feedback4. Tools for improving practice5. Conclusion and call to action

Agenda

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1. Appropriate product design and delivery2. Prevention of over-indebtedness3. Transparency4. Responsible pricing5. Fair and respectful treatment of clients6. Privacy of client data7. Mechanisms for complaint resolution

Client Protection Principles

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1. Client protection principles2. Understanding over-indebtedness3. Principle #2 in practice4. Participant feedback5. Tools for improving practice6. Conclusion and call to action

Agenda

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Identifying the Causes of Over-indebtednessMultiple loans

Poorly designed

repayment schedules

Inadequate capacity analysis

Unpredictable events

•Accidents, disease, or natural disasters

•The institution relies on guarantees as a substitute for adequate capacity analysis

•Repayment schedule does not match the client’s business cycles (e.g., agriculture)

•Multiple loans are issued to client, by one or more institutions, due to:−Lack of information on the client’s liabilities−Incentives for loan staff to oversell credit products

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How over-indebted clients affect the MFI

Increase in client delinquency

Portfolio provisioning prevents institution from making other loans

Slow and costly legal proceedings for collections

Damage to the institution’s image and portfolio

7Source: DAI

How over-indebtedness affects the client

Clients may …• Work longer hours• Reduce consumption• Use savings for loan repayment• Take new loans to pay off current debt• Sell assets, including productive

assets• Invest less in productive assets and

human capital• Search for help from family, depleting

relatives’ assets

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1. Client protection principles2. Understanding over-indebtedness3. Principle #2 in practice4. Participant feedback5. Tools for improving practice6. Conclusion and call to action

Agenda

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Prevent Over-indebtedness: The principle in practice

MFI

• Carefully establishes the borrower’s ability to afford the loan and repay it.

• Are able to handle debt service requirements without sacrificing their basic quality of life.

Borrowers

Consider this:

Research and practical experience show that borrowers consistently overestimate their own capacity to repay debt.

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Monitor over-indebtedness

Evaluate client capacity

Establish debt thresholds

Management and Board are aware of and regularly monitor client over-indebtedness.

Loan approval requires evaluation of client repayment capacity and loan affordability—approval is not based only on guarantee/collateral.Credit policies give guidance on debt thresholds and acceptable amount of debt from other sources.

The Principle in Practice

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Verify credit history

Audit credit procedures

Incentivize quality loans

If available, check the credit bureau. If unavailable, maintain and check internal records and consult competitors.Use internal audit to verify staff compliance with the procedures that prevent over-indebtedness.

Set targets and incentives that value portfolio quality as least as highly as portfolio size and growth.

The Principle in Practice (Continued)

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Example of Good Practices from Bosnia-Herzegovina

Practice Outcome

Good Practice: Interview delinquent clients.

Internal audit department conducts regular interviews of a sample of clients who have fallen behind on their payments. Two main areas of investigation:• Did loan officers follow proper

procedures to avoid over-indebtedness when issuing credit?

• What are the causes of the client’s repayment challenges?

The MFI uses the information to improve its credit procedures and to monitor risk.

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1. Client protection principles2. Understanding over-indebtedness3. Principle #2 in practice4. Participant feedback5. Tools for improving practice6. Conclusion and call to action

Agenda

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Feedback from ParticipantsWhat kinds of practices have you seen at your own (or other) MFIs that have contributed to over-indebtedness?

How has over-indebtedness affected clients’ ability to use credit effectively?

What consequences have over-indebted clients had on your institution?

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1. Client protection principles2. Understanding over-indebtedness3. Principle #2 in practice4. Participant feedback5. Tools for improving practice6. Conclusion and call to action

Agenda

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Technical Tools Getting Started Questionnaire: Self Assessment

for MFIsAvoiding Over-indebtedness: Guidelines for Financial and Non-Financial EvaluationSmart LendingSmart SavingsTechnical Guide for Investors

Samples and Case Studies

Client Business Evaluation Toolkit from Microfund for WomenLoan Calculator from Opportunity Bank SerbiaSmart Note: Facing Over-indebtedness at PartnerLoan Officer Training Manual from Banco SolidarioDebt Management Guide from NCR South Africa

Tools available from the Smart Campaign

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1. Client protection principles2. Understanding over-indebtedness3. Principle #2 in practice4. Participant feedback5. Tools for improving practice6. Conclusion and call to action

Agenda

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The Smart Campaign has developed seven principles of client protection, one is prevention of over-indebtedness.Client over-indebtedness negatively affects both clients and MFIs in serious ways. Good practices have been developed to prevent and correct over-indebtedness.The Smart Campaign has tools to help practitioners improve their practices to prevent over-indebtedness.

Conclusion

Call to Action: What do you see as the industry’s next steps for facing this problem? What are the next steps for your institution?

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Download the Getting Started Questionnaire and conduct a client protection self-assessment.

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