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Microfinance is a collection of financial services targeted towards poor and low-income clients to help stimulate income-producing activities, build assets, stabilise consumption, and protect against risks. In Cambodia, the microfinance sector has grown at a rapid pace over the last two decades leading to a significant increase in the delivery of financial services to the rural poor. While microfinance is designed to alleviate poverty and enhance economic development, increased competition between microfinance institutions (MFIs), many of which have a growing focus on profits, has led many to claim that the industry is suffering from ‘mission drift’. In particular, as the sector has struggled to expand the outreach of high-quality financial services, microfinance consumers have become increasingly over-indebted. As this is often due to low financial literacy affecting consumers ability to make prudent financial decisions, the Credit Bureau of Cambodia (CBC) was established with the aim of encouraging responsible borrowing and lending. In an attempt to improve the overall service level of the industry, the CBC has commissioned Destination Justice to create a multilingual online information platform and conduct a series of provincial workshops with the shared aim of disseminating relevant microfinance information to improve financial literacy and increase consumers’ awareness of their legal rights and responsibilities when they take out microfinance loans.
The Purpose of Microfinance
Microfinance is thought to be one of the most promising tools for economic development and the alleviation of poverty,[1. Armendaris de Aghion and Morduch (2000), ‘Microfinance beyond Group Lending’, Economics of Transition, Vol.8, pg. 402.] and empirical evidence suggests that microfinance can have a significant impact on poverty reduction.[2. Burgess and Pande (2005), ‘Do rural banks matter? Evidence from the Indian Social Banking Experiment’, American Economic Review, Vol. 95, No. 3, pp. 780 – 795.] The microfinance industry achieves this by providing financial services in small denominations to the poor. These services include lending, savings, insurance and remittances designed for poor clients that lack access to financial services from mainstream financial institutions. While microfinance is designed to support businesses by making improvements to productivity, technology and employment, and profitability,[3. Karlan and Vladivia (2006), ‘Teaching Entrepreneurship: Impact of Business Training on Microfinance Clients and Institutions’, Yale University Economic Growth Center, Discussion Paper No. 941, pp. 8-11.] these economic benefits can also contribute to the development of a broad range of related social benefits, such as female empowerment and vulnerability reduction,[4. Cohen and Sebstad (2000), ‘Microfinance, Risk Management and Poverty’, Microfinance Enterprise USAID, pg. 76.] food security,[5. Zeller (1997), ‘Rural Finance for Food Security for the Poor, Implications for Research and Policy’, Food Policy Review, No. 4, IFPRI, pp. 11-12.] and facilitating children’s access to education.[6. Chhay (2011), ‘Women’s economic empowerment through micro finance in Cambodia’, Development in Practice, Vol 21, Issue 8, pg.5.]
Cambodia’s Microfinance Environment and Over-Indebtedness
Despite the broad ranging benefits that microfinance has to offer, there is growing concern that the rapid expansion of Cambodia’s microfinance industry has diminished the industry’s overall social impact. From the industry’s humble beginnings in the 1990s, the sector has expanded to include 42 Cambodian Microfinance Association (CMA) members with a gross loan outstanding portfolio of approximately $USD 1,978 million.[7. Cambodian Microfinance Association (2012), ‘Microfinance Environment’, CMA.] Within twenty years of the establishment of the first micro-credit agencies in Cambodia, the industry had grown to encompass a borrow base of 1,901,153 accounts in 2012.[8. Ibid.] The majority of these accounts being held by women in remote areas.[9. Ibid.]
While the microfinance industry has enjoyed a high rate of repayment and a low level of default, empirical evidence suggests that consumers sacrifice access to other goods and services in order to repay their debts.[10. Liv (2013), ‘Study on the Drivers of Over-Indebtedness of Microfinance Borrowers in Cambodia: Abstract and Executive Summary’, Cambodia Institute of Development Study, pg.3.]
This is known as over-indebtedness. Over-indebtedness refers to the repayment capacity of borrowers by comparing their debt instalments to their net income.[11. Ibid.] While much ambiguity exists concerning the actual socio-economic impact Cambodian MFIs have on their clients due to the high costs of conducting impact assessments, available research suggest that a large proportion of borrowers are over-indebted.[12. Ibid.]
A recent study analysing the over-indebtedness of microfinance borrowers in selected saturated areas revealed that 22% of clients in a sample of 1,480 borrowers were insolvent or over-indebted.[13. Ibid, pp. 3.] While the study found that borrowers’ have a high tolerance for making sacrifices to repay their debts, 49% of borrowers adopted coping strategies that derogate from the social benefits of microfinance.[14. Ibid.] The most common coping strategies used by micro finance borrowers to meet their loan repayment obligations on time was to: (1) reduce the quality and quantity of food;[15. Ibid: 48% of borrowers reduced their quality of food and 44% reduced their quantity of food.] (2) sending family members to find work outside of the village;[16. Ibid: 27% of borrowers sent a family member outside of the village to work.] (3) depleting savings,[17. 25% of borrowers depleted their savings to cover loan repayments: see Ibid.] and; (4) taking new loans to cover existing debt. [18. Ibid.]
Drivers of Over-Indebtedness
While over-indebtedness has been attributed to a number of factors,[19. Schicks (2013), ‘The definition and causes of microfinance over-indebtedness: a customer protection point of view’, Oxford Development Studies, Vol. 41, No. 1, pp. 97-99.] a study using two separate analyses based on an objective definition of over-indebtedness and a clients’ struggle to repay revealed that over-indebtedness is driven by two main factors in Cambodia: multiple borrowing and financial literacy. [20. Liv (2013), ‘Study on the drivers of over-indebtedness of microfinance borrowers in Cambodia: An in-depth investigation of saturated areas’, Cambodia Institute of Development, pp. 59-59.]
According to the Global Call to Action Against Poverty, multiple borrowing is defined as an individual client or household borrowing from more than one MFI for the same or similar purpose.[21. Faruqee and Khalily (2011), ‘Multiple Borrowing by MFI Clients: Current Status and Implications for Future of Microfinance’, Institute of Microfinance, pp. 1-2.] In Cambodia, multiple borrowing is problematic, as it has been found to have the strongest positive correlation with over-indebtedness.[22. Ibid.] While aggregated national data approximates that 21% of total borrowers have multiple loans in Cambodia,[23. Ibid, pp. 1-2.] a recent study found that 56% of borrowers in remote areas had more than one existing loan.[24. Liv (2013), ‘Study on the Drivers of Over-Indebtedness of Microfinance Borrowers in Cambodia: An In-depth Investigation of Saturated Areas’, Cambodia Institute of Development Study, pp. 58-59.] In addition to affecting the economic well-being of consumers, in countries where microfinance has been studied in greater detail, multiple borrowing has also been found to negatively affect mental health by increasing financial stress.[25. Field, Rohini, Papp and Park (2012), ‘Repayment flexibility can reduce financial stress: A randomised control trial of microfinance clients in India, PLos ONE, Vol.7, No.9, pp. 2-3.]
As a result, policymakers have become increasingly concerned with the adverse affects that industry and client behaviour have on multiple borrowing as it affects the overall sustainability of the industry. In Cambodia, the rapid expansion and diversification of microfinance programmes has been accompanied by multiple borrowing.[26. Hoy and Foelster (2010), ‘Industry Update: Cambodian Microfinance’, Banking with the Poor Network, No. 2, pg. 3.] While competition has brought with it a number of positive effects, it has also led to concern that MFIs are engaging in unethical competitive practices and reckless lending that facilitates fast growth but lacks suitable assessments of client’s borrowing capacity.[27. Ibid, pp. 2-4.] The high rate of multiple borrowing in Cambodia has also been attributed to the inadequacy of loan sizes provided by individual MFIs, which has encouraged the tendency for consumers to take out new loans to cover their existing loan repayments. [28. Hoy and Foelster (2010), ‘Cambodian Microfinance’, Banking with the Poor Network, pp. 5-7.] Despite the limited number of impact assessment on multiple borrowing, the picture emerging from existing literature suggests that an increasing burden is being placed on poor borrowers who struggle to repay their debts.
Multiple borrowing is also caused by a lack of financial literacy among consumers. Financial literacy refers to the ownership of skills and knowledge that allows individuals to make prudent financial decisions.[29. Gajjala (2009), ‘Debt burdens and a lack of financial literacy: micro finance crisis, Tiffin University, PhD Thesis, pg. 5.] In Cambodia’s current climate of microfinance, borrowers with little to no financial literacy have been found to be more likely to have multiple loans, compared with those with higher financial literacy.[30. Liv (2013), ‘Study on the Drivers of Over-Indebtedness of Microfinance Borrowers in Cambodia: Abstract and Executive Summary’, Cambodia Institute of Development, pg. 3.] For example, borrowers with no financial literacy are more likely to have three or more outstanding loans and suffer insolvency or over-indebtedness.[31. Ibid, p.g 9.] This suggests that financial literacy is strongly associated with multiple borrowing and more generally, borrowers struggling to repay their debts.
The importance of financial literacy in Cambodia is also necessary due to a lack of pricing transparency and the use of technology and innovation making microfinance products increasingly complex to understand.[32. MFTransparency (2014), ‘Transparent Pricing in Cambodia, MFTransparency, date viewed 9 May 2014.] The importance of having financially literate consumers is needed to increase the demand for responsible use of financial services to help underpin financial market stability. According to UNESCO, “financial literacy empowers clients, making them knowledgeable about finance in a way that is relevant to their lives and allowing them to use this knowledge to evaluate products and make informed decisions”.[33. United Nations Educational (2011), ‘Scientific and Cultural Organization, Financial Literacy for Villagers: Financial Literacy’, UNESCO.] While 56% of Cambodian microfinance consumers were found to have zero to moderate financial literacy, those who were financially literate were more likely to save and engage in safe financial products.[34. Liv (2013), ‘Study on the Drivers of Over-Indebtedness of Microfinance Borrowers in Cambodia: An In-depth Investigation of Saturated Areas’, Cambodia Institute of Development Study, pg. 61.] These findings suggest that microfinance clients need a certain level of financial understanding in order to evaluate and compare financial products, such as bank accounts, saving products, as well as credit and loan options.
Credit Bureau of Cambodia and Destination Justice
The CBC was established in 2012 to respond to the rapid expansion of Cambodia’s microfinance industry and concerns that consumer and industry behaviour were leading to over-indebtedness. The CBC aims to reduce over-indebtedness by encouraging responsible borrowing and lending through the provision of accurate and reliable credit reporting that is essential to the financial stability, development and economic diversification of the Cambodian economy.[35. Credit Bureau of Cambodia (2014), CBC’s Mission, CBC, viewed 11 May 2014, http://www.creditbureaucambodia.com/about-us/credit-bureau-cambodiacom.html.] By providing a consolidated database on borrowers’ credit information, it is hoped that the CBC will facilitate MFIs ability to conduct due diligence and cross-check credit information reported by their clients, as well as resolve the information challenge that has previously plagued the industry and facilitated multiple borrowing. By providing a mechanism for the appropriate regulation and supervision of the microfinance industry, the CBC hopes to restore microfinance as a credible development tool.
Despite evidence suggesting that the CBC will ultimately help to increase access to credit among the poor, studies have shown an ambiguous effect on lending volume. Whereas some borrowers’ access to credit is improved because they are able to leverage their reputation towards larger loans, reputation information can also act against borrowers with any history of default.[36. Rozycki (2006), ‘Credit information systems for microfinance in India: Developing solutions to manage anticipated boom in sector growth’, Centre for Microfinance Working Paper Series, pp. 3-4.] As there is some evidence to suggest that the implementation of credit information sharing cuts poorer clients out of credit markets altogether,[37. Ibid.] the CBC has commissioned Destination Justice to create an online information platform and conduct a series of provincial roadshows designed to improve financial literacy and increase the public’s awareness of the nature of microfinance and their consumer rights. By highlighting the existence of the CBC to the Cambodian people, the online information platform and roadshows will explain laws, policies and regulations that govern healthy investment practices in a clear and accessible way. The initiative will also provide consumers with credit advice and avenues for redress in instances of risky, fraudulent or illegal activities. In doing so, Destination Justice and the CBC hope to expand the outreach of high-quality financial services and information to improve the overall service level of the industry in Cambodia.