Apparently credit is like good food: when seated at the table in front of a feast, many people eat too much and regret it later…

(Rhyne, 2001).

The incidence of multiple borrowing (read definition at the CGAP) is particularly high in competitive microfinance markets and is often a precursor of a repayment crisis, as in Bolivia. Rishabh Jain, in his recent article, Narrowing Benefits : Multiple Borrowing. Jain advocates that multiple borrowing can have both positive and negative effects on an microfinance institute (MFI) as well as its clients, as summarized below.

Trends Supporting Multiple Borrowing

Despite a demand-service level of only 9%, MFIs tend to cluster together in a few regions so new market entrants can “leverage training and screening of client by (current) MFIs and general awareness of microfinance in the area”. In the absence of much “geographic and product differentiation”, these microfinance institutes compete for the same clients in a few places, so one client may take out loans from different MFIs at the same time.

Reasons Client May Borrow From Multiple MFIs

Here’s a list:

• The client’s business needs exceed the loan offers by a single microfinance providers (to support growth, or a small business),
• Interest rates may vary across the sector, encouraging clients to go to a second microfinance provider,
• The client’s credit needs are not fulfilled by one MFI’s product ranges (some MFIs may only specialized in micro-crop loans, while others may excel in micro-insurance),
• The client may want to use additional microloans for consumption purposes or for an emergency, and
• In case of default, the client can take out a second loan to repay an earlier loan or simply start over after the first microfinance provider refuses to advance another loan due to a tarnished credit history. (This only occurs in the presence of information asymmetry about client indebtedness – read about a solution through credit bureaus).

From the MFI’s point of view, multiple borrowing partially ensures the first MFI gets its money back (in the form of a loan from the second MFI), which leads to good short-term repayment rates. Plus, these reasons suggest multiple borrowing is only a problem if the total debt exceeds the client’s repayment capacity, and sometimes, it does.

MFIs exacerbate multiple borrowing by ‘poaching’ clients of other MFIs, which involves visiting borrowers of competing microfinance providers and after gaining access to their credit histories, lure them by offering to promptly upgrade their loan sizes.

In the long run, rampant multiple borrowing can lead to “large scale defaults”.

Solution for Multiple Borrowing

Jain suggests microfinance providers must collaborate with one another to limit the harm done by multiple borrowing.

Both MFIs might be better off by reducing their loans outstanding by letting the other MFI share some of the risk by offering a complementing loan and monitoring could be shared to improve repayment…resulting in an optimal amount of joint monitoring that reduces costs to both parties.

A practical example of this sort of collaboration between to MFIs in Uganda can be examined at the following post: A Case of Multiple Borrowings.

The next post will focus on the impact of multiple borrowing on the client, as well as the MFI’s portfolio and employees.

Reference:

Jain, R. (2010). Narrowing Benefits : Multiple Borrowings. Available: http://www.microfinancefocus.com/2009/11/07/narrowing-benefits-multiple-borrowings/. Last accessed 3 June 2010.