The potential for digital borrowers to become over-indebted makes it necessary not only for regulators to develop ways to prevent and detect over-indebtedness but also to ensure that appropriate forms of resolution and exit are made available. Frequently, the financial authority’s direct jurisdiction extends from prevention and detection to some forms of forbearance and resolution but stops short of exit, i.e., providing for insolvency or bankruptcy processes. The actual exit procedure is usually prescribed in a separate body of law and handled by courts or specialized tribunals. Yet even where this is the case, the financial authority determines how defaults and insolvencies are treated on the FI’s loan books, and in some cases also how they are to be handled in the customer’s credit reports.
Although bankruptcy regimes have been set up for businesses in many jurisdictions, there is more limited experience with debt resolution regimes for individuals. Lacking this kind of framework, debtors are in some cases subject to long-term blacklisting, debt servitude, or imprisonment. The development of civil insolvency and bankruptcy laws in the industrial countries marked a major step forward both economically and socially. In most countries, however, these processes are not available to small-scale debtors, and so would likely require new legislation.
The usual alternatives have been debt holidays and moratoria such as were adopted during the pandemic, and one-off programs of debt resolution and partial forgiveness such as the Credit Repair Framework implemented in Kenya in 2021-2.1Debt restructuring measures in many countries have had a negative effect on the repayment culture, demonstrating the need to develop insolvency and debt resolution regimes, especially for individuals. Some hesitation here reflects doubts about the capacity of judicial officials to address these new types of cases related to personal finance.
Recommendation: An effective framework for over-indebtedness and insolvency would, at a minimum, include these basic elements:
- Debt advisors and counselors who evaluate the borrower’s situation and recommend the best actions to take at a personal finance level and with creditors.
- Bankruptcy regimes with simplified procedures for individuals, which usually entail a legal filing and court procedure that determines how an insolvent person works out unpaid obligations with their various creditors.
- Interim procedures to give borrowers a temporary break from creditor action. A personal insolvency regime should enable individuals to:
- Declare bankruptcy;
- Propose a debt agreement;
- Propose a personal bankruptcy agreement;
- Enter into voluntary bankruptcy;
- Exclude certain assets from the bankruptcy process if they are required to provide for the basic needs of the individual;
- Be discharged from bankruptcy and its associated debts (subject to reasonable exclusions) after a reasonable period of time; and/or
- Be protected from unreasonable or criminal sanctions (absent fraud) for declaring bankruptcy.
Country examples of personal insolvency frameworks
Bankruptcy law provides for an orderly resolution of insolvency claims for individuals.1It offers comparatively strong formal protections to the debtor and a fair and open resolution process to creditors. An individual debtor may seek liquidation or restructuring of the debt. Upon filing, legal debt collection action is paused. The accompanying rules on exemption (at state and federal levels) allow the debtor to retain a share of their property. Under the liquidation option, the debtor must turn over all non-exempt property to a trustee for liquidation, and the proceeds are then distributed to the creditors. Following this, the remaining debt may be relieved (“discharged”) immediately. Under the restructuring option, a debtor may save a greater share of her/his property, but does not obtain immediate debt relief. Instead, a reorganization of debt is proposed and a settlement plan agreed. Under this plan, the debtor repays all or part of the debt over 3 to 5 years (depending on income), and the remaining debt may be discharged upon completion. The CFPB also published guides for borrowers on how to work with credit counsellors.2
Consumers who are over-indebted (incapable of meeting debt obligations) may apply to a 'household debt commission' headed by representatives of government and the Banque de France. The commission assesses the level of indebtedness and decides between two procedures: either the negotiation of a settlement plan or the ‘personal recovery procedure’ (PRP). The former is a negotiated settlement proposed by the commission, agreed by the debtor and principal creditors, and lasting up to 10 years. Alternatively (often after attempts at a settlement), the commission may recommend the opening of the PRP in a district court, leading to the liquidation of the debtor’s assets. The debtor is then listed in a national register that can be consulted by all credit institutions.1
The Insolvency and Bankruptcy Code, 2016, provided a mechanism for personal insolvency called “Fresh Start.” Although this is part of the enacted Code, it has not been gazetted and therefore has not yet gone into effect. The insolvency application can be filed by a debtor or creditor at a specialized tribunal when the debt threshold of Rs. 1000 (US $12) is met. An interim moratorium takes effect upon the filing, during which time any legal action towards recovery of debt is stayed. The process provides a time-bound framework for debtors to negotiate a debt restructuring. The Fresh Start scheme is available to individuals with debts up to Rs. 35,000 (US $420), gross annual income under Rs. 60,000 (US $720), and total assets under Rs. 20,000 (US $240) with no ownership of a home.1
