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TANJA MEIER 07718505



& OV E R - I N D E B T E D N E S S

A rapidly growing Microfinance industry experiences a rising level of competition. While
competition is known to bring positive effects for customers, lower interest rates in the financial
industry, one cannot jump to a generally positive conclusion in Microfinance right away. While there
are certainly benefits arising, with more institutions offering more products, there are also negative
issues to consider. These adverse effects do not only affect the clients but also the organizations and
other stakeholders, ranging from deteriorating performance to customer over-indebtedness. This
paper will discus the most important findings about competition within the Microfinance industry
and pose some critical questions to consider.


Microfinance is still an evolving segment of the financial industry. It has however,

caught up over the past decade and the industry is growing rapidly. Starting out with the
purely socially motivated goal to alleviate poverty for as many people as possible,
microfinance institutions (MFIs) are becoming more and more profitable (Schicks 2010),
which also causes concern. As the industry grows, more institutions are joining to capture a
share of the profit.
From an economic perspective competition means more firms are competing for a
limited market share and thus having to adjust ever closer to the needs of the customers as
well as lowering prices down to a point where marginal revenue equals marginal cost (Stigler
2008). However, as theory has predicted and empirical analysis confirmed, in most places the
increase in competition among MFIs has not only brought benefits such as better access and
lower interest-rates, but has also introduced problems. These adverse effects fall back not
only on the MFIs, which are struggling to maintain their performance level, but also on the
clients. Borrowers are facing serious problems from paying back their loans, which
eventually increases the risk of over-indebtedness to increasing sociological and
psychological constraints (Schicks and Rosenberg 2011). Multiple factors contribute to this
problem, mainly changing lender and client behavior but also information asymmetries and
the lack of informational exchange between the MFIs play an important role.
The following will provide a critical review of the literature on microfinance
competition and its effect on stakeholders most importantly the poverty struck clients. The
paper is divided into four parts. Firstly, we try to capture the most important ramifications of
intense competition on the MFIs themselves. We will see that not only performance issues
arise, but also a change in lenders behavior. This is critical as it has an influence on the
wellbeing of borrowers. In the second part we will address competition in the microfinance
market and its consequences for the borrowers. The next part will show, that more than just
two stakeholders are affected by the rising competition and briefly talk about the
implications for incumbent banks and MFI employees. A fourth part looks at policy
implications and poses some critical questions for discussion, before we conclude.


A growing microfinance industry implies greater outreach and a change in market

conditions. The initially monopolistic operators are facing more competition. Competition is
healthy and beneficial for the customer as at least two or more companies are striving for
something that not all can obtain (Stigler 2008), it requires innovation and is generally said to
bring down prices or interest rates charged on a loan. While Hermes et al (2008) and
McIntosh and Wydick (2005) find that interest rates are indeed decreasing, one has to be
careful with this generally positive conclusion in the microfinance market. There can be
adverse effects arising on several dimensions.

By constructing a Lerner index, Assefa, Hermes and Meesters (2010) have found
empirical evidence that performance levels of MFIs differed significantly in high and low
competitive environments. The empirical investigation was based on 362 MFIs and 1247
observations in 73 countries, using data from the MIX market. The results showed that there
are adverse effects of competition for the MFIs. Overall, intense competition is negatively
associated with MFI performance, which was measured by outreach, efficiency, loan
repayment and profitability. With more MFIs entering the market, one would expect
outreach to be positively correlated with competition, meaning more people can be served
when competition increases. However, with rising default rates and falling profits the MFIs
prefer to stick with existing markets, where borrowers are considered safe and bring them
good return, thus lowering outreach. Other factors, which contribute to lower performance,
include information asymmetry, borrower over-indebtedness or changing clients behavior
(e.g. decreasing loan repayment); leading to a decline in efficiency and profitability of MFIs.
This calls for measures that ensure a minimization of the negative effects of competition
while still permitting growth within the industry. Assefa et al (2010) suggest that more
information sharing between MFIs, the elimination of information asymmetries and high
lending standards as well as efficient service provision are measures to address the problem
Another research on the effect of competition on MFIs was made by Hermes, Lensink
& Meesters (2008). They examined the correlation between MFIs outreach and efficiency

and uncovered a negative relationship. Their findings indicate that with a commercialization
of the industry, which more competition implies, MFIs become more concerned with their
financial efficiency. This in turn might cause them to turn their back on the poor and less
profitable customers. However, the study also shows that a more diversified portfolio of
products, such as savings and insurance compared to the traditional loans only, will be
offered, which is positive for clients.
Apart from performance problems another crucial consequence of competition on
MFIs deserves attention. With a market, that is reaching saturation, increasing competition
leads to lenders changing their behavior. MFIs try to maintain their customer base and
decrease their costs by lowering lending standards or decreasing screening efforts (Schicks
and Rosenberg, 2011). This results in higher risk borrowers and thus leads to a decline in
repayment and higher default rates. Furthermore, over-aggressive marketing such as
pressuring borrowers to take out a new loan after they have just paid off an old one adds to
the risk. Altogether, the changing behavior might trigger a very recent but severe
consequence - the rising risk of over-indebtedness.
So far we can conclude that the institutions themselves are generally worse of when
facing increased competition. Given the social objective of this industry it is however, much
more important to look at the borrower.

The rising level of competition implies a higher debt level among MFI clients, which
seems to have a direct impact on their economic and social wellbeing. In their explanatory
paper Schicks and Rosenberg (2011) examine conceptual issues and limited empirical
evidence about over-indebtedness in the microcredit market. They found that increasing
competition has adverse effects on clients and can eventually lead to borrower overindebtedness. There exist several definitions of over-indebtedness; in this context however,
we talk about over-indebtedness if borrowers have serious problems repaying their loans
(Schicks and Rosenberg 2011). This often implies a further impoverishment and increased
vulnerability of borrowers. There are several factors, which contribute to over-indebtedness.
First of all one has to acknowledge that clients do not always behave as fully rational homo
economics as assumed by classical economic theory (Rosenberg and Schicks 2011).
Behavioral economics (Kahnemann & Tversky 1979) has found that biases, such as an

over-confidentiality bias or a hyperbolic discounting, which mans discounting the future

too strongly and putting too much weight on the present, can lead to borrowers making bad
decisions like taking more debt than is good for them. Borrowers tend to take too much
debt and thus fall into serious repayment problems. The other side and probably the more
dominant factor is the changing lender behavior. As discussed above MIFs decrease their
screening efforts and start to relax their lending standards when they are confronted with
severe competition. Increasing loan sizes without sufficient investigation of clients ability to
repay puts the borrowers at risk. Other problems arise from a lack of clear and accurate
information about loan costs and terms, the use of over-aggressive collection practices and
inflexible loan products (Schicks and Rosenberg 2011). Recent debates address the issue
whether it is unduly risky to lend to borrowers for consumption rather then investment
related reasons (Schicks and Rosenberg 2011). The consequences for the borrowers can be
drastic. Major effects may include reduced consumption levels, downward spirals of everincreasing debt, late fees and a loss of creditworthiness. Sometimes sociological or
psychological effects are even more severe such as peer pressure or a loss of social position
and negative effects on mental and physical health. In extreme cases borrowers desperation
can even lead to suicide (Rosenberg and Schicks, 2011).
McIntosh and Wydick (2005), in their theoretical paper on competition and
microfinance show that competition may prove detrimental to some or all of the borrowers
in a microfinance market. In its initial monopolistic stage there are rents to be made for the
lender and it is profitable to serve both the more and less profitable participants due to cross
subsidies. Once competition sets in however, prices will be pushed down due to Bertrand
competition and client-maximizing behavior, thus rents will be eliminated. Lending
institutions then find themselves under greater performance pressure, due to which their
focus shifts to the more profitable segment of the market, leaving the more unprofitable and
mostly poorest and neediest on the sideline (McIntosh & Wydick 2005). The authors argue
that this process coupled with increasing information asymmetries can lead to negative
externalities for the borrowers. Especially, when differentiating customers along their
profitability and time preference characteristics, the poorest are neglected first and the least
patient borrowers are worst off, as they slip into double dipping or overlapping which
means taking out multiple loans. Due to decreased information sharing in a competitive

market, lenders will not be aware of the fact that their clients may be slipping into too much
debt, ultimately jeopardizing their financial health, but also putting the customer under more
strains. Therefore, the paper calls for optimized information sharing between lenders, maybe
even the establishment of credit bureaus. This must not only include la lista negra but also
la lista blanca, meaning not only the bad but also the good need to be monitored.

We so far have been focusing on the two obvious and most important stakeholders,
which are directly influenced by rising competition. In this section we have picked out two
additional stakeholders from the microfinance stakeholder network, namely incumbent &
commercial banks and employees.
McIntosh, Janvry and Sadoulet (2005) found in their empirical research that increased
competition induces a decline in repayment performance and lower savings amounts
deposited with the incumbent Village Bank. For their analysis they used data from Ugandas
largest incumbent microfinance institution. They uncover that the entrance of competing
lenders does not affect incumbent lenders ability to attract new client nor does it cause them
to lose clients. However, with no formal information sharing mechanism, borrowers rather
take multiple loans than abandon the incumbent lender, which leads to a deterioration in
repayment performance and to a drop in savings for the incumbent village banks. The
authors stress the necessity of institutional information sharing on client indebtedness levels
in order to assess the risk of double dipping.
Moreover, employees play an important role, when facing wrong incentives they can
add to the problem. Bad staff incentives include the encouragement of over-lending, offering
wrong products, obscuring loan terms and the use of abusive collection practices (Schicks
and Rosenberg, 2011). However, if MFIs set the right incentives for employees and increase
the awareness of the problem of over-indebtedness through employee training, there is a
good chance that staff can actually help to minimize the problems which intense competition
brings along.

There is one overwhelmingly clear fact presented in all of the papers examined - the
need for information sharing in the industry is great and increasing with the rise in
competition. Many call for a credit bureau that stores customers repayment history in a

central database accessible for all lenders. One can ask whether this is the sole issue that
could increase the benefits of the industry for both its protagonists, lender and borrower.
Moreover, Vogelgesang (2003) shows that this can have the intended effect, but also
cautions about that move. In an empirical study the author takes a look at the Bolivian
market, which she calls one of the most saturated microfinance markets. According to her
study of Caja los Andes, the biggest MFI in the area, a higher level of competition also
implies multiple loans, but also more timely repayment. She attributes this to the reputation
effect as customers credit history is monitored. This shows the positive effect of credit
bureaus other studies call for. It could be an important starting point for a comprehensive
policy approach in the microfinance market. However, monitoring can also have adverse
effects itself. As a study by McIntosh, Sadoulet and de Janvry (2006) shows, the use of credit
bureaus leads to a negative selection process. While it has little effect on the existing
customer base, new customers are selected with a preference for the wealthier ones, leaving
the poorer customers on the sidelines. This is not what MF set out to achieve.
Certainly the increased adverse effects need more awareness. There might also be the
need to call on the growing industry to think back to its root goal: social advancement. More
lending is fine and making profits, too. But keeping the focus on the social goal might help
to make both parties better off.
We have to ask ourselves if these adverse effects are strong enough to cause concern?
We have already shown that borrowers can get into serious repayment trouble, causing them
to suffer. Future perspectives so far dont give any reason to be optimistic about
improvements of this critical situation. Rather, the opposite is the case, as the market reaches
saturation, the problems are becoming more severe. This calls for an intensification in
attention, research and resources on the issue.
The question in this context is not whether microcredit has negative consequences for
the borrowers, but whether the benefit of microcredit still outweighs its negative effects.
Expectations about what microcredit can achieve have become more modest lately (Schicks
and Rosengard, 2011) and thus influence the level of acceptance for negative effects. If
microcredit helps the poor to deal better with poverty rather than raising millions out of
poverty the tolerance for negative effects should be much smaller.


This discussion examined the relationship between competition and microfinance.

Contrary to conventional economic theory, which highlights the benefits of competition for
the consumer, the empirical and theoretical literature finds adverse effects in the case of
microfinance, especially for the clients but also the institutions themselves.
Overall, there exists evidence that intense competition leads to a lower performance of
MFIs. Several factors are responsible for this development. Information asymmetries, the
lowering of lending standards or the acceptance of higher risk borrowers are just some
examples. Also borrowers changing behavior adds to the problem. They may lack financial
literacy and make bad decisions. Furthermore, external shocks are exaggerating their
problem. As a consequence borrowers suffer from negative effects of increased competition,
as they are having serious problems in repaying their debts. Intense competition negatively
affects their monetary but also sociological and psychological wellbeing. In extreme cases the
borrowers desperation can even lead to suicide.
Higher competition also leads to a shift to the more profitable segment of the market,
and thus leaving the poorest and neediest on the sideline. When customers are being
differentiated along their profitability and time preference characteristics, the poorest are
neglected first and the least patient borrowers are worst off. Most customers, especially the
poorest and most constraint, are falling into double dipping, taking out multiple loans,
increasing their repayment constraints (as found by McIntosh & Wydick 2005, Vogelgesang
2003, Mersland & Strm 2007, Navajas et al 2003, McIntosh et al 2005, Assefa et al 2010 in
different studies with various settings). This also causes the balance sheets of the institutions
to deteriorate.
Other stakeholders such as employees, incumbent banks and credit bureaus, also play an
important role when examining the effect of competition on the microfinance market.
Employees can make existing problems even worse when they are given wrong incentives.
Incumbent banks have to deal with a decline in repayment and savings deposits when
competition increases, as there is no formal information sharing between incumbent village
banks and other lenders, such as MFIs. The role of credit bureaus is ambiguous as they can
bring positive and negative effects when competition is intense.

Overall, we can observe that the behavior of stakeholders plays a central role, as they
influence each others financial wellbeing and thus can cause a vicious circle of negative

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