Debt Relief for Households in Developing Economies

Households in developing economies have greater access to formal credit today than at any point in history, owing to the global expansion of microfinance and recent innovations in consumer finance, such as digital lending. Although this has improved the ability to smooth consumption and invest in productive activities, it has also raised concerns about over-indebtedness. Against this background, this paper reviews and extends the literature on debt relief for households in developing countries. It begins by laying out a simple stylized model that illustrates the costs and benefits of debt relief. The model is used to guide the review of the evidence on various relief policies, such as debt forbearance, debt forgiveness, and personal bankruptcy. The paper additionally presents survey evidence from a population of microfinance and bank borrowers with recent exposure to debt relief. The results highlight that an important downside of discretionary debt relief policies, which are common in developing countries, is their potential to affect borrower expectations and create moral hazard. The development of legal bankruptcy institutions that offer a rules-based avenue to discharge unsustainable debts is a promising path to alleviate the credit market inefficiencies that have often accompanied debt relief initiatives in developing economies.