Principle #1 –
Avoidance of Overindebtedness
A special presentation for YOUR
INSTITUTION made possible by
the Smart Campaign
www.smartcampaign.org
Client Protection Principles
1. Avoidance of over-indebtedness
2. Transparent pricing
3. Appropriate collections practices
4. Ethical staff behavior
5. Mechanisms for redress of grievances
6. Privacy of client data
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Principle #1: Avoid Over-indebtedness
Providers take reasonable steps to ensure that
credit will be extended only if borrowers have
demonstrated an adequate ability to repay and
loans will not put the borrowers at significant risk of
over-indebtedness.
Similarly, providers will take adequate care that
non-credit, financial products (such as insurance)
extended to low-income clients are appropriate to
their needs and means.
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Principle #1: Avoid Over-indebtedness
What it means for the clients:
• Clients should make prudent decisions and
assume responsibility for their actions.
• Clients should be capable of making payments on
their debt without sacrificing their basic quality of
life.
What it means for the institution:
• A financial institution measures its compliance
with this principle by carefully assessing the
client’s capacity to successfully repay the loan.
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What causes over-indebtedness?
• Loans for amounts surpassing client’s debt capacity
- multiple loans at one or several institutions.
• Lack of information on existing liabilities (e.g. nonexistent credit bureaus or lack or reporting to credit
bureaus by other lending institutions).
• Incentives for loan officers to oversell credit
products.
• Products that do not match client’s business cycles
(e.g. agriculture).
• Institutions relying on guarantees as a substitute for
capacity analysis.
• Accidents, disease or natural disasters.
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What does over-indebtedness mean for MFIs?
Increase in client delinquency
Portfolio provisioning prevents
institutions from making other loans
Slow and costly legal proceedings
for collections
Damage to the institution’s image
and portfolio
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What does over-indebtedness mean for clients?
Borrowers and their family members work longer hours
Savings depletion
Sale of assets, including productive assets
Reduction of consumption
Less investment in productive assets and human capital
Borrowers take new loans to pay off current debt
Search for help from family, depletion of relatives’ assets
Source: DAI
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Photo of Presenter
INSTITUTION:
• Founding & Organizational
Status
• # clients
Institutional Logo
NAME,
TITLE
• Bullet about experience
• Bullet about experience
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Presenter Takeaways
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Questions or comments for the presenter?
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Photo of Presenter
INSTITUTION:
• Founding & Organizational
Status
• # clients
Institutional Logo
NAME,
TITLE
• Bullet about experience
• Bullet about experience
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Presenter Takeaways
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Questions or comments for the presenter?
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What actions can MFIs take?
Solid Credit
Methodology
Adjust to
Market
Needs
•
•
•
•
Standardized, well-documented implementation
Track record of good credit evaluation
Establish limits on lending to indebted clients
Check credit bureaus where they exist
• Offer loan consolidation products
• Make loans based on business size and
investment needs
• Develop refinancing policies that take into
account real repayment capacity
• Require higher guarantee coverage ratios
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Source: Apoyo Integral, El Salvador
What actions can MFIs take?
Monitor
Portfolio
Quality
• Monitor client use of loans
• Follow-up Credit Committee analysis with
oversight on actual borrower capacity and
delinquency
• Goal-setting with clients on monitoring visits
Good
Customer
Care
• Decrease client incentive to take loans from
multiple institutions
• Quick, timely, and personalized customer
service to increase loyalty
• Additional service offerings (insurance, etc.)
• Outreach to ignored market segments
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Source: Apoyo Integral, El Salvador
Beyond Codes: Indicators of Good Practice
Management Awareness of Risks
• Management regularly obtains information on client over-indebtedness and uses it to
respond appropriately to risks.
Management Monitors Lending Practices
• Management regularly monitors product performance and lending practices and
uses the information to improve operations.
Effective Capacity Analysis
• The loan approval process requires evaluation of borrower repayment capacity &
loan affordability. Loan approval does not rely solely on guarantees (whether peer
guarantees, co-signers or collateral) as a substitute for good capacity analysis.
Clear Debt Thresholds
• Credit approval policies give decision makers explicit guidance regarding borrower
debt thresholds and acceptable levels of debt from other sources.
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Beyond Codes: Indicators of Good Practice
Check with Credit Bureau
• When available, the financial institution checks a Credit Bureau for borrower current debt
levels and repayment history. When not available, the financial institution maintains internal
records and when possible, consults with competitors for same.
Multiple or Flexible Products
• The financial institution offers multiple loan products or flexible ones that address different
business and family needs
Incentives Should Balance Growth and Portfolio Quality
• Incentives and productivity targets reward risk management. Productivity targets and
incentive systems value portfolio quality at least as highly as other factors, such as
disbursement or customer growth. Growth is rewarded only if portfolio quality is high.
Internal Audit Monitors Adherence to Lending Methodology
• Internal audits check household debt exposure, lending practices that violate procedures
including unauthorized re-financing, multiple borrowers or co-signers per household, and
other practices that could increase indebtedness.
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Good Practices from Beyond Codes
In addition to implementing a rigorous credit methodology to
ensure that clients are capable of repaying their loans,
one MFI in Bosnia-Herzegovina:
• Tasks its internal audit department with following up on a
sample of clients who have fallen behind on their
payments.
• Has the internal audit team conduct client interviews.
• Focuses interviews on ensuring that loan officers followed
proper procedures to avoid over-indebtedness.
• Includes in the interview a focus on diagnosing the
causes of the client’s repayment challenges.
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Discussion
We have talked about multiple examples of good
practices that are currently in use, but overindebtedness continues as one of the key problems
MFIs face in many countries.
What do you see as the next steps to address this?
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Next time…
We will discuss Principle #2:
Transparent & Responsible Pricing
We will examine concrete examples:
• What is transparency?
• How can you tell if clients understand the
information shared with them?
• What role does financial literacy play?
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Questions?
Contact the Smart Campaign
For more information visit:
www.smartcampaign.org
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Protection
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Thank you!
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