Comment: how much microcredit is too much?

The detractors of micro-credit often point to clients becoming over indebted, or having more than one micro-loan out from multiple providers. Responsible micro-credit banks are trying to address the issue. An essay in the Huffington Post today gives one take on answering this issue.

Elisabeth Rhyne from the Center for Financial Inclusivness points out that overindebedness is often hard to determine in the under-developed world. Rhyne says one way to answer this problem is by determining the about of sacrifices one makes to pay off the loan.

Overindebtedness is sometimes equated with multiple borrowing. In many markets where microfinance has grown fast, microlenders crowd in to compete with one another to reach a finite number of customers. In these settings, poor clients often take loans from several competing lenders. Some may even use one loan to pay off another. Is that overindebtedness? Not necessarily.

Middle class people often juggle credit cards, mortgages, car and school loans successfully, and the same goes for the poor. A pathbreaking book published in 2009, Portfolios of the Poor: How the World's Poor Live on $2 a Day, reveals that the vast majority of the world's poor lead complex financial lives. They continually tap relatives, employers, savings clubs, and informal moneylenders to keep their financial lives on track.

It is not uncommon for a poor household in Bangladesh or South Africa to "turn over" -- borrow, lend, deposit, withdraw -- ten times the net household worth in the course of a year. Rapid turnover is necessary in large part because the incomes of the poor tend to be uneven and unstable as well as low. They need financial intermediation to tide them over periods of little or no income.

If poor people already have many financial arrangements at a time, then multiple loans from microlenders are not alone evidence of a problem. It's the stress in debt stress that needs to be examined.

The definition of overindebtedness I favor, developed in dialogue with Richard Rosenberg of the Consultative Group to Assist the Poor, who has explored the question in depth on the CGAP blog, revolves around the idea of sacrifice. If a family has to make sacrifices that significantly affect their quality of life, or if a micro-business has to make sacrifices that reduce its income generating capability, that's debt stress.

Many people get into debt stress at some points in their lives. They scrimp on groceries for a couple of weeks to have the cash for next month's loan payment. Or they miss loan payments because a lingering illness keeps them away from their business. That's acute overindebtedness. While acute debt stress can be serious, some temporary overindebtedness is a normal part of the ups and downs of life; it might not mean that a person has borrowed too much.