Is Credit Irresistable?

September 15, 2009

A basic point I feel I have not pondered enough is that people who are financially cornered may borrow unwisely—at least sometimes. A Microfinance Insights article by Lilian Simbaqueba and Vitalie Bumacov of the Colombian credit-scoring company LiSim made me think of this now:

With limited access to mainstream credit services, the availability of an opportunity to borrow is overwhelmingly attractive to microcredit borrowers. A “good” opportunity, meaning availability of the right amount of loan at the right time, is a driving factor for microfinance clients to borrow, often without deliberate consideration of the potential risks involved.
…
Even in a mature market like Peru, microfinance institutions have to “think for both” themselves and their clients. Easy availability of credit offers a bigger temptation for clients to borrow simultaneously from different sources. Competition among credit institutions may ease the approval or renewal of policies. If the MFI is not aware that the borrower has other current loans, it cannot asses the over-indebtedness of the applicant and, by consequence, can disburse a “low-risk” credit, which in reality is very risky for the client and for the institution. Microborrowers tend to hide this information while MFIs strive to obtain it. In the absence of a credit bureau, this task is nearly impossible.

Or consider a quote from Sanae Ito’s 1999 Ph.D. thesis, which (the quote, that is) is based on a conversation with some teachers and a carpenter in southern Bangladesh:

[T]hey were of the opinion that [Grameen] Bank members who ran around desperately trying to borrow repayment instalment money from relatives and neighbours before the bank meetings could not possibly be experiencing any reduction in their poverty. When I asked them why they thought that the bank members were still so desperate to take loans despite such difficulties, the assistant head master answered: “It seems to me that they borrow to meet their immediate financial needs, which have no limits of course.”

As it happens, Ito married Stuart Rutherford, an author of Portfolios of the Poor.

Do you think Simbaqueba and Bumacov have a strong point here? Or are they, in their enthusiasm for their credit-scoring business, which is founded on the premise that borrowers cannot be trusted to filter themselves, somewhat exaggerating the importance of their work? Is Portfolios of the Poor more on-target in its humble trust in the ability of the poor to manage their own affairs?

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1. Richard Webb Says:
   September 16th, 2009 at 4:46 am

   David Roodman, With two colleagues at the Instituto del Peru, of the Universidad de San Martin de Porres in Lima, we are finishing a history of microfinance in Peru. It should be published by end-Sepember. I would be hapy to share it, and even more, to dicuss some of the results. I am an economist and have served two terms as president of Peru’s central bank and was a co-author of a history of the World Bank published by Brookings, but am very much a new-comer to microfinance – for better or worse! I love your Open Book idea, but at my age I am behind the curve on blogging. On your specific question, I can only give my intuition – the Colombian authors you cite are entirely right. I have seen it time and again. I’m sure that learning to manage debt levels can happen, but mostly it doesn’t. I don’t think being rich or poor has much to do with it. By the way, the most fun chapter in our book is called Microfinance Before Microfinance, and is mostly about the wildfire creation of credit cooperatives and S&Ls in Peru between the 50s and 70s. At their peak, their savings, loans and membership were huge. Ninety percent of them had failed by 1990, though coops are making a bit of a comeback now.

   Good luck.

2. Sara Duke Says:
   September 17th, 2009 at 12:34 am

   Could it not be, that microfinance clients are just exercising a choice/option for credit, which had previously been denied to them? One doesn’t have to look far to find over-extension of debt when afforded this choice, even for educated groups.

   “•Average credit card debt per [American] household — regardless of whether they have a credit card or not — was $8,329 at the end of 2008. (Source: Nilson Report, April 2009)
   Overall, (in 2008) American consumers had an average of 5.4(credit) cards.
   •Eighty-four percent of the student population overall have credit cards, an increase of approximately 11 percent since the fall of 2004. (Source: Sallie Mae, “How Undergraduate Students Use Credit Cards,” April 2009)
   •Only 2 percent of undergraduates had no credit history. (Source: Sallie Mae, “How Undergraduate Students Use Credit Cards,” April 2009)
   •Half of college undergraduates had four or more credit cards in 2008. That’s up from 43 percent in 2004 and just 32 percent in 2000. (Source: Sallie Mae, “How Undergraduate Students Use Credit Cards,” April 2009)
   •Since 2004, students who arrived on campus as freshmen with a credit card already in-hand have increased from 23 percent to 39 percent. (Source: Sallie Mae, “How Undergraduate Students Use Credit Cards,” April 2009)”
   •41 percent of U.S. adults, or more than 92 million people living in America, gave themselves a grade of C, D, or F on their knowledge of personal finance. (Source: National Foundation for Credit Counseling, 2009 Financial Literacy Survey, April 2009)
   •Almost three in four surveyed say they don’t bother reading the terms and conditions of their own credit cards. (Source: CreditCards.com survey, June 2007).”

   http://www.creditcards.com/credit-card-news/credit-card-industry-facts-personal-debt-statistics-1276.php

   And these facts come from 2004 data:

   About 43% of American families spend more than they earn each year.
   Average households carry some $8,000 in credit card debt.
   Personal bankruptcies have doubled in the past decade.

   http://moneycentral.msn.com/content/SavingandDebt/P70581.asp

   Then there is the US national (government) debt, currently standing at a record all-time high of more than 11.5 trillion USD or close to 90% of GDP.

   So the point being, that if the world’s super-power and its educated young adults can become such a “debt junkies,” what assumptions can we rightfully assert for microcredit clients in the “global South”?

   While credit scoring may serve as a filter, financial education is what is desperately needed worldwide, beginning as early as possible in life. Thankfully, changes to curriclum in recent years for US public middle school students, has permitted the exposure to financial education. So children can help their parents balance their checkbooks and learn about healthy financial behavior early in life.

3. Tim Ogden Says:
   September 17th, 2009 at 2:31 pm

   Perhaps a better way to ask the question is, “Is Temptation Irresistible?” At least that makes the answer much clearer. Of course, then we have to ask the follow up question of how we help people resist temptation. Credit bureaus are one way of resisting the temptation to overindebtedness but they certainly don’t seem to solve the problem where credit bureaus exist, particularly among those least able to resist temptation. So how do we help people resist temptation?

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