A Case of Multiple Borrowings

Austin Harris, KF11 Rwanda

In September 2009, Vision Finance Company (VFC), a major microfinance bank in Rwanda, established a branch office in Rwamagana, a city in eastern Rwanda.  Urwego Opportunity Bank (UOB), another major microfinance bank in Rwanda, had established a branch office in the same area in June of that same year.  The two branch offices are located just across the street from each other.  Shortly after VFC began lending money, it noticed the number of delinquent payments and defaults were much higher than normal.  This trend continued and the cause remained unknown.  During this time, the delinquent payments and defaults were rising at the UOB branch as well.  In April 2010, VFC conducted an investigation and found that many of its clients who had taken loans with UOB also had taken loans with VFC during the same time.  Both microfinance banks were unaware of their clients borrowing from multiple sources and it was proving to be financially detrimental to both banks.

When clients borrow from more than one microfinance institution at the same time it can lead to repayment difficulties.  Multiple borrowings by clients can often result in over indebtedness.  As clients increase their debt load, they have less room to absorb economic shocks.  Overall, this higher debt level will raise the risk of the loans for each lender.  Microfinance institutes try to prevent this, but the process can be difficult.

How Multiple Borrowings Occur

For most developing countries, there is no state-level credit agency for microfinance clients.  Microfinance institutes (MFI’s) have to perform their own credit checks to assess the ability of the client to repay.  One difficulty with this credit check is determining if the client has any outstanding loans with other microfinance institutes.   There is the option of sharing client lists among MFI’s in the region, but most are opposed to providing this information.  There is a fear that giving a competitor your list of clients will enable that MFI to lure your clients to them for future loans.  Since a loan history is usually not available, this enables clients to approach more than one MFI if they seek greater financing.

Why Clients Take Multiple Loans

There are a variety of reasons why clients will take out loans with more than one MFI, some more risky than others.  One reason is that MFI’s may have limits to their loan sizes that are inadequate for expanding the client’s operations.  This is especially true when a client begins with an MFI and has not yet qualified for larger loan sizes.  Another reason is that unexpected events may require additional cash for the client.  For example, a marriage, sickness, or house repair may necessitate funds that cannot be covered by the client’s original loan.  A client may also take out another loan to pay existing loans.  Though risky, this can provide the client more time to generate funds to pay off her debt.

Growing Trend of Multiple Borrowings

The rapid growth and commercialization of the microfinance sector has increased competition among MFI’s for clients. This often results in more than one MFI operating in an area, and many times too many MFI’s to serve the customer base feasibly.  This competition can be beneficial to clients in that interest rates may be lowered, number of financial services may be expanded, and the quality of services may improve.  However, there is a danger to this growth and competition in that client poaching, reduced monitoring, and reckless lending may occur.

In many areas of the developing world, microfinance growth is leading to the risk of multiple borrowings by clients.  For example, Indian microfinance covers several million borrowing clients, and is amongst the fastest growing globally.  In the last decade, the microfinance industry has grown many fold and has attracted many other MFI’s into the market.  This unprecedented growth and new competition has made governance of the loans more difficult.  Clients have been able to take advantage of the greater competition and borrow from multiple MFI’s, contributing to the rise in risk of these loans.  It is not unheard of to discover a client with five outstanding loans.

Similar repayment troubles from rapidly growing microfinance markets have occurred in many other countries, such as Nicaragua, Pakistan, and Morocco.  For example, Morocco has seen some of the fastest growth in microfinance within the last decade.  During this time, however, nonperforming loans started to rise significantly.  It went from having one of the lowest risk levels in the earlier part of the decade to extremely high levels by the end.  Many factors contribute to this rise in risk, such as overstretched MFI’s, lenient loan policies, outdated information systems, and poor governance.  In Morocco, as in India and other growing microfinance markets, a major contributing factor to the rise in risk has also been the rise in multiple borrowings.

What Can Be Done in the Industry

MFIs have methods that can be employed to reduce the incidence of multiple borrowings.  An MFI can improve the appropriateness of disbursement timing so a client will receive her loan at the necessary time.  This prevents the need to seek other loans to ensure financing is available.    Also, implementing cash flow-based lending can enable the MFI to provide loans that are sufficient and affordable for the client’s business.  This practice should help the client receive the appropriate loan size and not need to seek extra financing elsewhere.  In addition, initiating state-level MFI forums and sharing data about outstanding loans can reduce the frequency of multiple borrowings.

UOB and VFC Solutions to Multiple Borrowings

To contend with the problem of multiple borrowings in Rwamagana, UOB and VFC have come to an agreement.  They have decided to share their lists of existing clients at the end of each month.  If a client appears on both banks’ lists, the client is monitored very closely throughout the remainder of her loan. When the client finishes paying her loan, the banks demand that she chose one of the banks.  Ideally, the banks would be able to check for outstanding loans when a client completes a loan application, but that level of coordination does not yet exist.  I also question if the two competing banks trust that the other bank would not poach its clients if the client’s info was shared before the loan was finalized.

This practice of sharing client lists has spread to other areas where UOB and VFC both operate.  Fortunately for these banks, they control a sizeable majority of the market and do not have to contend with many other competitors.  As the market grows and new competitors enter, they may face the difficulties of discovering more clients with multiple loans.  At that point, the MFI’s of Rwanda, like the MFI’s in countries with growing microfinance markets, will have to find more effective solutions.

Austin Harris is a Kiva Fellow with Urwego Opportunity Bank (UOB) in Rwanda and a member of the Friends of UOB lending team.

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