During the course of a loan contract, the instalment plan can affect the borrower’s ability to repay.
Products that are too inflexible and repayment schedules that are too far out of step with borrowers’ cash flows can drive borrowers into over-indebtedness even when the debt amount is reasonable.
When individual borrowers are struggling with liquidity problems rather than structural debt problems, the zero tolerance policy that has been the mantra of many lenders may need to be relaxed.
The policy is valuable in teaching borrowers the importance of regular repayments, especially compared to typical government lending.
It promotes the early recognition of repayment difficulties and keeps borrowers from piling up obligations.
The policy reduces the risk of spill over effects of delinquency on non-delinquent borrowers and avoids the operational cost of handling large numbers of rescheduling requests.
Nevertheless, if the zero-tolerance policy is so strict that there is no room to accommodate legitimate individual circumstances, the result can be an unnecessary increase in the struggles of honest borrowers.
A related issue concerns collection methods.
Once borrowers get into trouble, inappropriate collection practices can worsen their situation. While a certain level of firmness is necessary to provide sufficient repayment incentives, collection needs to respect the basic rights of borrowers.
Also, if the lender charges substantial penalties for late payments (over and above continued accrual of regular interest), it may place itself in the dubious position of making higher profits when clients can’t or don’t pay on time, which is hardly an incentive to minimize over-indebtedness.
Lenders sometimes increasingly face accusations of employing collection practices that unduly increase the burden of indebtedness for borrowers, humiliating and intimidating them or depriving them of assets.
Borrowers are not necessarily aware of their rights and, for example, consider it normal for a lender to force borrowers to discuss their delinquency in public, to extend group meetings at the cost of business time or punishment by husbands, or to seize assets in spite of an uncollateralized loan contract.
At the same time, if collections are too lax, repayment difficulties may materialise too late when over-indebtedness has already become unavoidable.
After a loan cycle has been completed, it is difficult for some lenders to accept that borrowers sometimes need a break from credit rather than an immediate follow-up loan.
A lender can then just offer other services that would bind clients to the institution than further debt.
Outside influences:
One set of factors that can push borrowers into over-indebtedness is outside the control of the lending parties.
In spite of sound lending decisions, external shocks to the income or expenses of a borrower can turn a debt load unsustainable.
Credit problems are most frequently due to drops in expected income or rising expenses.
Besides personal shocks, such as illness or job loss, macroeconomic developments such as a financial crisis can drive borrowers into such difficulties.
Factors typical for developing countries may be natural disasters and changes in government policies (e.g. displacement of street vendors) or political crises.
Changes in government policies can affect input and market prices, or displace street vendors. According to Stearns, 1991, macroeconomic contractions and currency fluctuations can impair many borrowers’ repayment capacity.
Individual borrowers are hit by household-specific external shocks, most commonly a sudden reduction in income (e.g., a job loss or illness in the household) or a large unexpected expense (e.g., an accident, medical costs, or funeral obligations).
Other shocks affect many borrowers at the same time—e.g., natural disasters or conflicts that destroy livelihoods.
Institutional and legal environment:
This may also influence the behaviour of lenders and borrowers.
For example, the existence of credit bureaus, the efficiency of the judicial system, and the level of competition can enhance or reduce the risks of over-indebtedness.
There have been complaints about lenders at the slow pace of the judicial system in Zambia especially as relates to default and bankruptcy proceedings in Zambia.
Indeed this is one of the reasons why the Commercial registry, Small Claims Court and Arbitration processes have been put in place by the Government to address this problem.
Products that are inappropriate to the borrower’s situation also increase over-indebtedness.
For example, if maturities are short and instalment plans or schedules inflexible this can make it difficult for borrowers with volatile incomes to repay on time.
The difficulties get exacerbated if lenders are reluctant to reschedule loans for honest borrowers in liquidity difficulties.
This has been a major problem especially with the Small and Medium enterprise sector where their cash flow problems may be exacerbated by their main clients like the mining companies not paying them for supplies within the agreed time-frame.
I also referred to an earlier situation where, within, the same week, I was offered by the same institution, a mortgage, credit card, car loan and top-up personal loan!
Honestly, how possible is it that the same client could qualify for all these products at the same time?
Repayment capacity also is a function of loan use.
The most frequent product feature borrowers cite as a reason for repayment problems is the timing of disbursements.
Productive investments, especially those subject to seasonality, require cash when the investment opportunity exists.
If lenders disburse too late, customers may not earn returns.
On a similar line, consumer loans are frequently identified as a source of over-indebtedness as they do not provide debtors with returns for repayment.
The focus of many, especially micro lenders, on women can contribute to over-indebtedness. Research has revealed that loans to women are often used by husbands.
Indebting female borrowers who may not have control over their resources and loan use can be a catalyst of over-indebtedness.
Socio-demographic and economic characteristics:
The most common socio-demographic factors include young age, more and younger children, low levels of education and low or unstable labour market status.
Single adult households and those with recent changes in family composition such as divorce, are at risk as well as people in rented accommodation as opposed to home-ownership.
Ill-health, gender and ethnicity are also related to indebtedness.
Many of these characteristics are prominent among micro-finance customers and might also be related to indebtedness in the developing country context.
These factors should be taken into account in avoiding over-indebtedness.
The most common economic factor in the literature is low income.  Income instability, low wealth and low returns on the borrower’s investment are also important factors.
Lenders might overestimate the returns on investment for their borrowers and not take into account that a large share of loans is not actually put to productive use.
To sum up, causes of over-indebtedness include external influences, adverse shocks to the income or expenses can turn debt unmanageable.
Similarly, the institutional and legal environment can enhance or reduce the risks of over-indebtedness. In microfinance markets in developing countries, institutional protection from over-indebtedness may be weak.
A significant share of the responsibility for over-indebtedness also lies with lenders.
Lenders can push borrowers beyond their limits due to an exaggerated focus on portfolio growth and by means of aggressive marketing techniques.
They sometimes offer products that are inappropriate to the borrower’s situation, enforce unrealistic instalment schedules, resist the need to reschedule loan agreements, artificially limit maturities etc.
Lenders also contribute to over-indebtedness due to their operating procedures, being lax about evaluating repayment capacity, offering untransparent terms and conditions and using coercive collection practices.
Finally, micro borrowers play an important role in their own over-indebtedness.
Due to cognitive limitations, difficulties to resist temptation and sociological pressures, they sometimes make irresponsible borrowing decisions.
The tendency towards over-borrowing also depends on borrowers’ socio-demographic and economic characteristics, many of those that are related to over-indebtedness being particularly prominent among the microfinance target group.
If a credit relationship leads to over-indebtedness that is usually the result of interacting factors. If a borrower made perfectly informed, rational decisions, not giving in to temptation or social pressures, a lender could face little risk to over-indebt this customer.
At the same time, if the puts its business mission and customer interest above all other goals, designed products that perfectly matched their customers’ needs, carefully evaluated repayment capacity and took the psychological limitations and biases of their customers into account in their communication and lending decisions, even imprudent borrowers would hardly be at risk.
In reality, both parties are bound to make mistakes given the complexity of the situation and their information asymmetries.
Adverse shocks may turn even the best borrowing and lending decisions into over-indebtedness triggers in some cases.
It is therefore important to design measures to prevent over-indebtedness that tackle as many of the over-indebtedness reasons as possible.
For the remaining borrowers that can still not be protected from over-indebtedness, additional curative and rehabilitative customer protection measures are required.