Multiple Loan Cycles – A Never Ending Cycle?

20 July 2010 at 15:34 14 comments

Matt Raimondi, KF11

The long-term viability of the microfinance industry depends on microfinance institutions’ ability to develop a sustainable business model.  Microfinance Institutions, after all, are business ventures; they must be financially viable in the long run or they will eventually be forced to fold and shut their doors.

Like many businesses, MFI’s depend heavily on repeat customers.  i.e. people who take out loan after loan, often increasing the loan size with each loan cycle.  Prior to my Kiva Fellowship I was naive to this practice.  While I understand the reasons behind this business strategy, I have struggled to accept it as reality.  It’s true, despite my capitalistic beliefs I also believe that MFIs have a social responsibility to their clients.  Some clients I have spoken to can’t even remember how many loans cycles they have had, many having had upwards of 20 loans throughout their relationship with the MFI.  I often ask myself: Are multiple loan cycles a necessary evil? Are they really evil?  Are clients being taken advantage of?  Do multiple loan cycles create a dependence on the MFI?  Do micro-loans really lead financial independence and improved quality of life?  Do clients understand what they are getting into?  Are MFIs creating a never ending cycle?

As I near the end of my Kiva Fellowship I would like to share the conclusion I have come to.  The answer to each of these questions is…I don’t know.

On that note, let’s discuss the effects on clients of multiple loan cycles as a business strategy.

First, the negatives.

Loan disbursals are a joyous occasion for microfinance customers.  Many have never had so much money at once and the loans give them hope and empower them.  However, we all know how addictive easy debt can be after the recent worldwide economic disaster caused largely by over-indebtedness.  Once you taste the good life it’s hard to go back.  Hence, many clients are eager to take out their next loan and MFIs are happy to provide them with financing and possibly a bigger loan.  Loan officers are often encouraged to sell clients on subsequent loans and up the loan amount whether the client needs it or not.  Clients that take out more money than necessary tend not to invest the money as wisely and can lead to problems paying back the loan.  This can cause over-indebtedness and dependence on loans, creating a seemingly never ending cycle of loans to support their new lifestyle.

Now, the positives.

MFIs are businesses and repeat clients are the best clients and have a huge effect on profitability.  By lending to the same clients it helps to mitigate risk and the unknowns that come with new clients.  Multiple loan cycles help build a relationship and allow an MFI to offer improved, more customized service.  Multiple loan cycles offer clients a steady stream of capital instead of one off large injection of capital, allowing them to continue to grow their business and improve their quality of life.

At the end of the day an MFI is providing a service to it’s clients.  Like any business, to be successful they must offer a service that people want and need.  I have met with countless clients and a common theme is how thankful they are for the loans.  Many are longstanding clients and are proud that they have been able to go through multiple loan cycles and are adamant that the loans have improved their lives.  They see no issue with having had so many loan cycles.  I still worry about over-indebtedness and dependence on the loans but I have come to accept that multiple loan cycles are an essential business strategy for MFIs to be successful and are not much different from credit cards or loans that businesses in the developed world employ.

What do you think?  I’d love to hear your thoughts…

Matt Raimondi is currently serving as a Kiva Fellow at FAMA OPDF in Juticalpa, Olancho, Honduras.  FAMA OPDF is a pilot Field Partner and recently posted their first Kiva loans.  Click here to support FAMA OPDF by making a loan to one of our entrepreneurs. Click here for more information on FAMA OPDF.

Entry filed under: blogsherpa, FAMA Honduras, Honduras, KF11 (Kiva Fellows 11th Class). Tags: , , , , , , .

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14 Comments

  • 1. Caroline Walcot  |  25 September 2012 at 01:50

    In the West we live all the time on repeat loans and endless credit and regard this as completely normal. It’s called bank overdrafts and credit cards – but the principle is the same: the borrower gets money (s)he would not otherwise have and is expected to repay until the credit amounts diminish substantially, probably not to zero.

    I don’t see how we as lenders can possibly criticise borrowers for taking out repeat loans, since the options of overdrafts and credit cards are not available to them. However, it does make it more important for Kiva to check most thoroughly the credentials and performance of each MFI Field Partner (a process known as “due diligence’) before Kiva loans are made.

    If a past borrower is taking out a fifth loan, I would never query this, as long as at least the first, second and third loans were paid off first.
    If the fourth loan finishes off while the fifth loan is started, that is just like someone in the West having a negative balance at both the bank and on a credit card, and also have outstanding payments to make on a mortgage or a car.

    The whole business of financing is based on mutual trust: trust that the borrower will pay back the whole and trust that the lender will not suddenly foreclose. If Kiva backs an MFI and monitors it, then that’s quite enough for me.

  • 2. Rose  |  24 September 2012 at 12:52

    I do not have that much time of experience in the MFIs world… I think that was something I did not even considered before starting working in one, which is a Kiva partner. I’m right at that point: am I doing something to help or to ruin this world even more? :S does not feel ok, but fortunately here in the MFI there is a Non-Financial Services Dept. I’m sure there are still many things I can do for the clients. I just need to define and work on my projects… It was nice to read you Matt and to read many other comments. Jeff, the clients definitely would go to someone else, even if there is a higher interest rate…

  • […] microloans with a small stake of wealth from which they can build capital. Rather, they end up in a cycle of borrowing so dire that a self-questioning Kiva fellow notes that “some clients I have spoken to can’t even […]

  • 4. Magdalena  |  2 August 2010 at 15:02

    Great post, Matt. An overwhelming majority of all loans in my MFI in the DR are repeat loans. I have come across the same situation of a borrower not remembering how many loans it’s been since they started with Esperanza and not being able to describe the business objectives to be financed by taking out loans in every-increasing amounts. I had the same reservations as you brought up, but, after reading your blog and the many interesting comments to it, I think I agree with Jeff. These entrepreneurs’ businesses would suffer greatly if they were refused their next loan. It also seems to me that if credit cards are routinely used by ordinary consumers in developed nations on an ongoing bases, relying permanently on credit to run a small business doesn’t seem that strange any longer. Cheers! Magda

  • 5. Fehmeen | Microfinance Hub  |  26 July 2010 at 09:51

    One of the problems you mentioned is moral hazard (i.e. clients investing the money in sub-optimal places), and the easy solution is simply, better monitoring of the loan to ensure clients aren’t borrowing for the sake of borrowing, or for purposes other than business (or the stated purpose of the loan).

  • 6. Alma Jones  |  26 July 2010 at 03:36

    I found this article very informative and up-to-date. I totally agree with the views of the writer that the custom signs play an important role in order to increase the business profits and build brand image of your company among the masses. These signs not only help your existing customers find your place of business, but also help you draw high percentage of the potential customers into clients and increase profitability of the company. These signs are very vital to your business success.

  • 7. Caroline  |  24 July 2010 at 04:36

    This is an unexpectedly interesting debate!!
    We have a clash of cultures here – lenders from the First World vs people of the Third and Fourth Worlds with less than minimal resources.

    Pam is right, we should not generalise the arguments.
    My plea is that one size does not fit all.

    Mongolian herders, having lost all their livestock in the most recent dzud (caused by us driving SUVs in the west?), have to find some way to live and to repay the loans they took out last year for fodder to feed their animals that still died. The only money they got was a pittance from the UN from burying the carcasses. This situation is far more heartbreaking than when car loans stilll have to be paid off after a crash if the insurance didn’t pay up.

    These people cannot be given a one-off huge loan that suddenly sets their whole lives straight. It may take six or seven consecutive loans before herders can either retrain and start up viable new businesses (eg as butchers) or pay off their old debts, buy new animals, and get started again. It will certainly take years. Meanwhile they have to survive in the slums around Ulaan Baator doing something. Of course, in this situation I’m happy to lend more than once to the same person. They are not succumbing to “staying in indebtedness”.

    Elsewhere you get the retail businesses where the borrower wants to expand. Why not? all viable businesses want to do that eventually. Seed corn capital is only that- enough to get you going but no more.
    Here it’s up to each individual lender to check out both the borrower and the MFI credentials on the Kiva site (which is excellent and very open), and if you are cautious, stick to 4 & 5-star MFIs, while if you are a gambler or true philanthropîst you may accept the risks of 1 – 3 star MFIs. They lose star ratings not only for mismanagement but also due to external circumstances like war, famine, floods, earthquakes etc – not a daily occurrence for most First Worlders.

    In the end, microfinance wastes far less money than humanitarian aid, and the dollars go straight to where they are needed. Experience has shown (Ecuador) that Kiva must be quick to react if any MFI is discovered to be a bad egg, but that should not be allowed to stain the records of the others; if their interest rates are too high, Kiva must review the star rating, or publish the information on site; if the MFI in question is the only organisation in the area, there’s usually no choice for Kiva but to deal with them.

    When lenders have actually lived in some of the countries or under some of the circumstances experienced by many of the borrowers, there is generally more understanding. Have you ever lived in a place for 2 months with a daily allowance of one litre of water for personal use ? I have, and boy did I learn about recycling!

    Instead of worrying about the primrose path to indebtedness, put yourself in their shoes – sometimes they pinch somethin’ awful.

    • 8. Antoine S. TERJANIAN  |  24 July 2010 at 07:17

      Yes, Pam is right, we should not generalise the arguments, and one size does not fit all.
      I have the highest respect for entrepreneurs who constantly struggle to build and deliver a better device that makes human life more liveable and in the process improve their own lot. And yes, from 2003 to 2008, I, personally, had no regular water at our house on top of our mountain in Yeghegnadzor and walked twenty minutes down to the public fountain to refill and carry back a few bottles and I have been at the forefront of recycling and minimizing my environmental footprint whether in Canada or Armenia. And the main reason I decided to establish a foothold in Armenia is to alleviate these kind peoples’ suffering and help them develop.
      I am a strong proponent of Micro-credit and know of its positive impact, when used properly.
      And again YES: microfinance wastes far less money than humanitarian aid, but this does not mean that we should not remain vigilant and denounce abuses of the system whenever we find evidence to it, and that we should not continue to devise ways to identify the abuses and improve our approach.
      After all, ‘we’ have limited resources. Should I continue to loan the same Mongolian herder who did not save enough when s/he was given a first chance at a loan, or should I now offer the same chance to ‘another’ Mongolian herder suffering under the same conditions!
      And, I join Matt Raimondi in admiting that “I don’t know” the full and unequivocal answer and that I am following this thread to learn more.
      Respectfully. AST

  • 9. Antoine S. TERJANIAN  |  22 July 2010 at 14:53

    Yes: Food for thought!
    With his innocent sounding “I don’t know” Matt Raimondi has hit the nail right-on. Thank you Matt for a very honest and thought-provoking essay.
    Why should we worry if Kiva is seen to be involved in a repeating, never-ending debt cycle? Because there is an obvious conflict of interest! “The long-term viability of the microfinance industry depends …” on finding people who will pay them interest which will pay for their offices, salaries and lifestyles. Not necessarily “for the sake of alleviating poverty”, which is Kiva’s main stated objective.
    We are facing the classical case of “institutional survival”: the survival of the institution (with its staff and vested interests) becomes more important than the aim for which the institution was originally created.
    Yes there are legitimate businesses everywhere in the world, whose business plan includes a healthy interest payment, but would we go as far as giving out a loan to a borrower when we know s/he will use it to pay-back a loan taken at another institution? Doesn’t this mean that the original business plan was not good enough to allow the entrepreneur to make enough money to pay-back the loan and generate some net profit which could be re-invested? Could that mean that the interest charged by the MFI was too high, consequently the entrepreneur’s ability to pull-out of poverty is compromised?
    Looking at it from another angle identified by Mr. Raimondi: are we “addicting/baiting” poor people to the “good-life” and the easy road of falling more and more into never-ending debt?
    I totally agree with Donald Nordeng and am eager to learn of his experience in Japan with the American mentors. Please email me aterjanian(at)yahoo.com

  • 10. Laura Buhler (KF8)  |  21 July 2010 at 12:34

    Interesting question…

    I’d like to flip this around and ask whether private-sector big-business would get rid of the debt section of their balance sheet? The answer would be emphatically “no”. A healthy, balanced portfolio of debt, equity and assets are just a part of running and financing a business in the developed AND developing world. It’s also the way many of us have chosen to live. I don’t really plan on ever getting rid of my credit card, nor would I ever try to buy a home on cash or propel a business entirely through equity.

    I’m only posing the question… why are we now so worried about subjecting borrowers to the “cycle of debt” when we were once only concerned with giving them the choice for the first time in their lives to access that debt? Jeff, if we did refuse them the second loan, an entrepreneur is once again excluded from the financial system and her business is now restricted from growth. She can buy the sewing machine, but once her business has grown, cannot access a loan to finance hiring a new staff member.

    Food for thought?

  • 11. Caroline  |  21 July 2010 at 04:51

    I don’t have a problem with repeat loans, as long as the usual precautions are observed.

    Maybe some Kiva lenders have never run a small business and would not understand the need for rolling credit in order to ensure good operation.

    I do run a small business in the EU, and it’s not easy. Without rolling credit (ie bank overdraft facilities), it’s absoluytely impossible – I would never be able to pay all my providers on time because my suppliers often delay an extra 30-60 days before paying up. Tax authorities, utilities and insurance companies etc are never flexible, and many providers would collapse if their invoices were persistently ignored. Rolling credit or top-up operational credit is needed to smooth over the rough patches when income simply does not come in.

    Once seed capital has been paid to get a microbusiness off the ground, there will inevitably be needs later for extra operational cash just to run the business: eg for a retailer to buy in new stock before the shelves run dry, for a farmer to buy fertilizer or fodder in the mid-season when there is no crop to sell, no livestock to slaughter. Remember, most entrepreneurs have families to support and children to house, feed and educate.

    The important thing is that any run-on loans required for operation should be in proportion to the business, and so the MFI should not create indebtedness: each new loan should be carefully calculated to enable payment of all suppliers AND taxes AND business rates AND staff AND loan repayments from the business income. (Sorry for the capital letters, but these overheads often add up hugely, and in some poor areas, there may be local taxes and handouts (bribes) to pay as well.)

    Too many newcomers to business underestimate the hidden overhead costs that are incurred by any business that is healthy.

    Again, I have no problem with repeat loans – as long as the MFI and Loan Officer monitor the recipients. Regarding the Fellow’s article itself, I believe the “I don’t know” the answer is probably the right one.

  • 12. Pam  |  20 July 2010 at 22:23

    Doesn’t it depend on the nature of the borrower’s business and what the loan is used for? As a practical matter, there are MILLIONS of well run businesses in the US that routinely depend on operating loans to balance out cash flow. No one thinks this is bad or unusual. It is the way business in this country operates. If this is what some of those repeat loans are for, then the question becomes is this what microfinance is supposed to be doing? And to my way of thinking, there can be honest differences of opinion: should microfinance be limited to capital loans or should operating loans be included? On the other hand, if the multiple loans are due to unwise expenditures or, heaven forbid, borrowing to pay off prior loans, then that would, to my mind, present an entirely different question.

  • 13. Donald Nordeng  |  20 July 2010 at 17:18

    Clearly this is not the MFI business model Kiva lenders want to support. I for one do not. The point of getting an entrepreneur started and going is getting them seed capital and then helping them to run their business. A business model based on repeat borrowers is not the best for the MFI nor for the society.

    A more balanced portfolio of services such as saving programs, management services, educational programs, financial planning services will lead to a more positive cash flow for the bank and a way to attract new clients. Free introductory seminars as well as low cost seminars will be the key to growing the business. While it may be naive,

    While MFIs are in the business of lending now, borrowing itself is in many cases unnecessary because the business is unnecessary. The high rate of business failure in the US for example is mainly due to a lack of good market research and good business advice before the venture was launched. In other words, businesses that shouldn’t have been started were started, and when they were dying they were prolonged too long with debt.

    According to a writer for Barrons, Jim McTague in 2005, “America has two economies: First, there’s the legitimate economy, in which craftsmen are licensed and employers and employees pay taxes. Then there’s the fast-growing underground economy, where millions of nannies, construction workers, landscapers and others are paid off the books, their incomes largely untaxed. The best guess as to the size of the output of this shadow economy is about $970 billion, or nearly 9% that of the real economy. It could soon pass $1 trillion.”

    When looking at villages with mainly this second underground economy, our goal as Kiva lenders I think is to help economies bring entrepreneurial businesses into the legitimate economy, pay for utilities, taxes, and support other villagers with jobs that are paid in compliance with labor regulations. Supporting MFIs that hook entrepreneurs into multiple loan cycles is not as bad as supporting loan sharks, but the stench of bait is in the air.

    I may be naive, but as I have mentioned, getting businesses off the ground is key to supporting economies. This Friday I will participate in an event where the US Embassy in Tokyo will launch a program to mentor 20 Japan based entrepreneurs to encourage this kind of activity in Japan. The number one economy is helping the number two economy to grow. Now, lets put this into perspective. What if Kiva MFIs also had mentor programs that they charged for or that were supported by donors or government funds? If it is needed in the US and Japan, clearly it is needed anywhere. Any volunteers?

  • 14. Jeff  |  20 July 2010 at 16:36

    Good topic, Matt.

    It might be constructive to consider it from the other direction: what if, after paying back their loan, borrowers were refused another loan? Would they just say “Oh well, I guess I didn’t really need another loan.” or would they go elsewhere to get their next loan.

    …..Jeff


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