Schicks (2014) demonstrated that “A microfinance customer is over-indebted if he/she is continuously struggling to meet repayment deadlines and structurally has to make unduly high sacrifices related to his/her loan obligations” (p.302). Haas (2006) and Alam (2012) defined over-indebtedness as the inability of settling the loans fully and on time and Haas (2006) further described it as social exclusion and increasing of social vulnerability and it generates high and lasting welfare costs for the society. Over-indebtedness is an economic condition of a borrower where the client fails to meet the repayment obligation or the total loan from the net income in a month or year or situation where the borrowers are pushed to sell their productive assets to pay the installments or settle the total loan below their subsistence level (Alam , 2012) Further Alam (2012) stated that the likeliness of occurring and the time of occurring over-indebtedness can be considered as a function of current and future income, assets, and also the features of the loan contract like interest rates, repayment schedule, and fees.
According to Gonzalez (2008), Over-indebtedness can arise when defaults occur as borrowers are unwilling to repay the loans even they have the necessary capacity and secondly when the borrowers have to make some costly sacrifices to settle the loans and those situations are beyond that anticipated at the time of the loan agreement and finally, even though the borrowers are like to settle the loans but unfortunately they do not possess the required ability and due to that arrears, partial repayments or full repayment problems take place.
As a subjective measurement of over-indebtedness, a microfinance borrower is considered as over-indebted when their total debt repayment costs exceed the net income during a defined timeframe. Moreover, the net indebtedness index has been used as a subjective measurement to measure the over-indebtedness and it is calculated by dividing the total monthly installments on all the business and household debt by the monthly net income which is the income after the expenses excluding the debt servicing expenses. Based on the figure denotes from the index, households are considered as insolvent when their net indebtedness index is greater than 100 percent, further if the index is lies between the range of 76 percent and 100 percent, that borrowers are considered at risk and finally, if the net indebtedness index is less than an equal 75 percent, they are insolvent (Liv, 2013).
Maurer and Pytkowska (2010, as cited in Alam 2012) measured over-indebtedness in terms of the debt service payments with the net income and a net indebtedness index was calculated by dividing the total monthly installments on household debt by the monthly household income. Based on the index the clients were classified into three groups. If 100 percent of the income was used to settle the debt payments and the net over-indebtedness index was equal to or exceed 100 percent, that customer was classified as over-indebted and if the consumers have used their net income over 75 percent to settle the loans and where the index was between the 75 percent and 100 percent, that customer was classified as at risk of becoming over-indebtedness and finally if the customers spent less than 75 percent to settle the loans and index is below 75 percent, that customer falls under the category of not over-indebted.
Schicks (2014), who is regarded as one of the pioneers in the microfinance over-indebtedness literature, presented a sacrifice-based definition for the over-indebtedness and also subjective measurement for the over-indebtedness. Schicks introduced a list of sacrifices after interviewing a large number of borrowers and classified those under three main categories. The first category was the basic needs and it included a reduction in food, education, and other important expenses and the second category was the economic chopping categories and it included additional work done by the households, reduction in savings, loan recycling and also selling of the assets to serve the debt expenses. The final category was the social or psychological sacrifices and it was consisted of asking the help, insults, harassment, and psychological stress.
Moreover, to measure the over-indebtedness should need to rate the frequency of the occurrence of the mentioned sacrifices suitably as under the frequencies of once in the past year, in between 1 and 3 times in the previous year, more than 3 times but not often or as frequently. After that their sacrifices were ranked in terms of the acceptability of the sacrifices as “easily acceptable”, “only just acceptable”, “not really acceptable” or “not acceptable”. Finally, if the borrowers experience unacceptable sacrifices that were structural and struggle to repay the loans, those are considered as over-indebted. If the borrower experienced a minimum of 3 repeated unacceptable sacrifices, those are known as structural. However, the structural one-off sacrifices, selling off assets, unacceptable loan recycling, and asset seizures are not needed to be repeated experiences.
Schicks (2010) provided a considerable and remarkable contribution to the existing literature about the over-indebtedness of microfinance borrowers and the causes that drive it. The first set of factors she has mentioned is the factors behind the control of the borrowers and lenders. For example, external shocks, adverse shocks to income, and expenses of the micro borrowers can push them into a debt level that they cannot manageable and also personal shocks like illness, loss of employment, and macroeconomic developments like financial crises and their impact on the economy can push borrowers into unmanageable financial positions. Another main factor is the institutional and legal environment and it can affect both the lenders and the borrowers. The behavior of the lenders also can drive the consumers on to over-indebtedness and they can do so through aggressive marketing techniques, pushing and over encouraging borrowers to borrow debts beyond their limits, offering inappropriate products, lending procedures, and also collection procedures. Moreover, Schicks (2010) mentioned behavior of the borrowers also can lead to over-indebtedness and this can happen due to numerous cognitive and psychological biases, self-discipline, and borrowers’ difficulties when balancing their utilities. Further, as sociological influences, pressures come from the society, materialism which motivate people to make expenses than their possible limit, inequality, social comparison and, economic socialization can drive borrowers towards over-indebtedness and ultimately socio-demographic and economic characteristics can push borrowers into over-indebtedness.
Further, causes for over-indebtedness can be mainly categorized under two groups as social factors and personal factors. Job loss and durable unemployment, business failure, income-poverty, separation or divorce, and illness fall under social factors while insufficient financial literacy, excessive consumption, inappropriate financial services, and addiction falls under personal factors (Haas, 2006). Schicks (2013, as cited in Schicks 2014) showed a combination of borrower level, the lender -level and external factors as the drivers of over-indebtedness and socio-demographic factors, economic characteristics of borrowers, business and loan-related factors, sociological influences, and psychological influences falls under the borrower level factors. Moreover, job loss, fall in income, credit withdrawal, and a major expense are regarded as some most relevant forms of shocks (Gathergood, 2012). Alam (2012) stated lender behavior, bad decisions of the borrowers, and external factors like illness, a natural disaster that is beyond the control of both parties can lead to over-indebtedness of the borrowers.
Opportunistic behavior of the microfinance lenders can drive borrowers into over-indebtedness and due to this behavior, not only the opportunistic lenders have to face the negative consequences but also other non-opportunistic lenders, depositors-regulator, and also borrowers themselves have to face the negative consequences. Further, high competition among the lenders, information asymmetry, a recession, and other unexpected shocks to income and expectations of debt forgiveness can drive borrowers to behave opportunistically and this also can be introduced as a reason for the over-indebtedness (Gonzalez, 2008). The following section will provide an overview of the drives of over-indebtedness by addressing the previous literature.