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Causes of Loan Default in Microfinance


Microfinance has made it pretty easy for the poor self-employed and small entrepreneurs to access financial services such as saving, borrowing and insurance. These are services that they were earlier struggling to access from the banking sector. However, there are numerous microcredit institutions that are currently facing troubles due to increasing cases of defaults. These have been linked to the following:

  1. Institutional factors
  2. a) Improper appraisal procedures

This is a situation where the lending officer makes the wrong judgment by failing to make important considerations like cost of investment, projected returns, competition and risks involved among other factors. Lending officers may also overlook certain lending policies especially when dealing with friends, family or past clients. All this exposes the microfinance to risks of default.

  1. b) Inadequate support

After disbursing the loans, the microfinance is supposed to do a follow-up to ascertain the progress, identify any challenges and come up with way of sorting them out. However, there are cases where such support is not availed and the small entrepreneurs are left to struggle with their challenges. This leaves their businesses at higher risks of crumbling making it hard to clear their loan balances.

  1. c) Competition

There are other numerous lenders extending credit financing today including banking institutions, credit unions and private lenders. In a bid to beat the competition, microfinance institutions may be forced to use some incentives like fewer requirements and giving out funds without collateral. This then leaves them at higher risks of losing their cash and reduced chances of recovering defaulted amounts.

  1. Client-based factors
  2. a) Poor investment decisions

Before submitting an application, there are various factors that the applicant should consider including the right investment opportunity, starting capital and operating costs among others. It is very easy to invest in the wrong economic or business activity if such factors are not considered properly and the income generated may not be enough to match the agreed repayment plan.

  1. b) Inadequate skills

There are important skills required to run a business efficiently including record keeping, financial management, marketing, problem solving, networking, time management and customer service among others. Lack of such skills can greatly affect the general performance and future growth of the business. This can also make it hard to come up with alternative strategies where initial decisions do not work.

  1. c) Personal crisis

There are cases where defaults have been attributed to personal crisis such as medical bills, job loss and death among others. Persons involved in such situations may encounter problems trying to raise the required loan repayment amount. They may also divert the available funds to sort out the problems they are facing.

  1. External factors
  2. a) Economic distress

A new business can start up well but later face economic challenges caused by factors such as inflation, recession, volatile prices and volatility of exchange rates. There are businesses that are also seasonal and they are also likely to experience similar challenges during the low season. These are problems that can make it hard to remit the required repayment amounts.

  1. b) Natural disasters

Occurrence of natural disasters like earthquakes, tsunami, landslides or avalanches, floods and volcanic eruptions can affect normal operation of a business. This is where such occurrences can cause inconveniences like damages to the inventory and interfering with infrastructure. The business is therefore likely to experience challenges in trying to settle the expected loan amount.

  1. c) Government policies

Before setting up a business, all cash projections and loan repayments are based on the existing government policies. This means that any changes made to such policies will have an effect on the projected figures for example, higher corporate taxes will lead to a lower profit margin. This will in turn affect the expected loan payments if the repayment plan is not adjusted.