Over-Indebtedness: A Risk Management Approach

This paper provides a brief overview of the risks surrounding over-indebtedness and also intends to provide support and guidance to risk managers at MFIs. It outlines a summary of the environments (specifically in Mexico) in which over-indebtedness becomes more likely, the parties that will be affected, and the recommended mitigants to MFIs tackle this risk. Recommendations include:

• Mandate quality credit reporting to a universal credit bureau;
• Strengthen the process of borrower screening;
• Maintain awareness of competitive hot spots and monitor closely for signs of over-indebtedness;
• Adopt a provisioning policy with an increasing scale based on the number of client loans;
• Engage with leading self-regulatory consumer protection initiatives, such as the Smart Campaign and MFTransparency;
• Provide financial education with loans, particularly covering with clients the importance of affordability and the risk of over-indebtedness;
• Practice lending methodologies that take into account payment capacity rather than relying entirely on the group support/pressure in some communal and solidarity methodologies;
• Collect credit information frequently and with good quality control;
• Implement good corporate governance practices, which although are time-taking, function as a good mitigant;
• Encourage the formation of a specialized regulator to formulate policy guidelines and to monitor the performance of unregulated institutions that grant credit.