Principle #1 – Avoidance of Over- indebtedness A special presentation for YOUR INSTITUTION made possible by the Smart Campaign

2 1. Avoidance of over-indebtedness 2. Transparent pricing 3. Appropriate collections practices 4. Ethical staff behavior 5. Mechanisms for redress of grievances 6. Privacy of client data Client Protection Principles

3 Providers take reasonable steps to ensure that credit will be extended only if borrowers have demonstrated an adequate ability to repay and loans will not put the borrowers at significant risk of over-indebtedness. Similarly, providers will take adequate care that non-credit, financial products (such as insurance) extended to low-income clients are appropriate to their needs and means. Principle #1: Avoid Over-indebtedness

4 What it means for the clients: Clients should make prudent decisions and assume responsibility for their actions. Clients should be capable of making payments on their debt without sacrificing their basic quality of life. What it means for the institution: A financial institution measures its compliance with this principle by carefully assessing the client’s capacity to successfully repay the loan. Principle #1: Avoid Over-indebtedness

5 Loans for amounts surpassing client’s debt capacity - multiple loans at one or several institutions. Lack of information on existing liabilities (e.g. non- existent credit bureaus or lack or reporting to credit bureaus by other lending institutions). Incentives for loan officers to oversell credit products. Products that do not match client’s business cycles (e.g. agriculture). Institutions relying on guarantees as a substitute for capacity analysis. Accidents, disease or natural disasters. What causes over-indebtedness?

6 Increase in client delinquency Portfolio provisioning prevents institutions from making other loans Slow and costly legal proceedings for collections Damage to the institution’s image and portfolio What does over-indebtedness mean for MFIs?

7 Search for help from family, depletion of relatives’ assets Borrowers take new loans to pay off current debt Less investment in productive assets and human capital Reduction of consumption Sale of assets, including productive assets Savings depletion Borrowers and their family members work longer hours Source: DAI What does over-indebtedness mean for clients?

8 NAME, TITLE Bullet about experience INSTITUTION: Founding & Organizational Status # clients Photo of Presenter Institutional Logo

9 Presenter Takeaways

10 Questions or comments for the presenter?

11 NAME, TITLE Bullet about experience INSTITUTION: Founding & Organizational Status # clients Photo of Presenter Institutional Logo

12 Presenter Takeaways

13 Questions or comments for the presenter?

14 Standardized, well-documented implementation Track record of good credit evaluation Establish limits on lending to indebted clients Check credit bureaus where they exist Solid Credit Methodology Offer loan consolidation products Make loans based on business size and investment needs Develop refinancing policies that take into account real repayment capacity Require higher guarantee coverage ratios Adjust to Market Needs Source: Apoyo Integral, El Salvador What actions can MFIs take?

15 Monitor client use of loans Follow-up Credit Committee analysis with oversight on actual borrower capacity and delinquency Goal-setting with clients on monitoring visits Monitor Portfolio Quality Decrease client incentive to take loans from multiple institutions Quick, timely, and personalized customer service to increase loyalty Additional service offerings (insurance, etc.) Outreach to ignored market segments Good Customer Care Source: Apoyo Integral, El Salvador What actions can MFIs take?

16 Management regularly obtains information on client over-indebtedness and uses it to respond appropriately to risks. Management Awareness of Risks Management regularly monitors product performance and lending practices and uses the information to improve operations. Management Monitors Lending Practices The loan approval process requires evaluation of borrower repayment capacity & loan affordability. Loan approval does not rely solely on guarantees (whether peer guarantees, co-signers or collateral) as a substitute for good capacity analysis. Effective Capacity Analysis Credit approval policies give decision makers explicit guidance regarding borrower debt thresholds and acceptable levels of debt from other sources. Clear Debt Thresholds Beyond Codes: Indicators of Good Practice

17 When available, the financial institution checks a Credit Bureau for borrower current debt levels and repayment history. When not available, the financial institution maintains internal records and when possible, consults with competitors for same. Check with Credit Bureau The financial institution offers multiple loan products or flexible ones that address different business and family needs Multiple or Flexible Products Incentives and productivity targets reward risk management. Productivity targets and incentive systems value portfolio quality at least as highly as other factors, such as disbursement or customer growth. Growth is rewarded only if portfolio quality is high. Incentives Should Balance Growth and Portfolio Quality Internal audits check household debt exposure, lending practices that violate procedures including unauthorized re-financing, multiple borrowers or co-signers per household, and other practices that could increase indebtedness. Internal Audit Monitors Adherence to Lending Methodology Beyond Codes: Indicators of Good Practice

18 In addition to implementing a rigorous credit methodology to ensure that clients are capable of repaying their loans, one MFI in Bosnia-Herzegovina: Tasks its internal audit department with following up on a sample of clients who have fallen behind on their payments. Has the internal audit team conduct client interviews. Focuses interviews on ensuring that loan officers followed proper procedures to avoid over-indebtedness. Includes in the interview a focus on diagnosing the causes of the client’s repayment challenges. Good Practices from Beyond Codes

19 We have talked about multiple examples of good practices that are currently in use, but over- indebtedness continues as one of the key problems MFIs face in many countries. What do you see as the next steps to address this? Discussion

20 We will discuss Principle #2: Transparent & Responsible Pricing We will examine concrete examples: What is transparency? How can you tell if clients understand the information shared with them? What role does financial literacy play? Next time…

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