# **3 Types of Debt Relief and their Effects**

This section reviews the different types of debt relief available to households, and the existing evidence on their effects on borrower behavior and access to finance. There are many different forms of debt relief that can be grouped into _de facto_ and _de jure_ debt relief, as well as temporary and permanent debt relief measures. These policies are not mutually exclusive and are often available concurrently, especially in a crisis. We focus on describing the broad features of each type of debt relief policy as well as evidence from studies measuring the effect of specific policies. International comparisons of debt relief programs and their effects are notoriously difficult because of idiosyncracies in program design and the lack of internationally comparable outcome measures.<sup>6</sup>

## **3.1 Loan Default**

The simplest form of debt relief is loan default or delinquency, which occurs when a borrower makes zero or less than the minimum required payment on a loan.

While default can provide _de facto_ debt relief, it can have significant costs in terms of future access to credit. In recent years, many jurisdictions have expanded their credit reporting systems to include smaller personal loans and microloans in individual credit records. In most cases, non-repayment of any formal loan will therefore trigger a negative credit bureau entry and reduce a borrower’s future access to formal credit. By making it easier for creditors to learn about past defaults, the presence of credit registries can increase the costs of default, thus reducing the moral hazard costs of debt relief.

It is unclear, however, to what extent borrowers internalize this cost. In a study of Indonesian credit card borrowers, for example, Bursztyn et al. (2019) find that nearly half of all respondents are not aware of the existence of a credit bureau or the consequences of non-repayment. When consumers do not fully internalize these costs, this can increase the moral hazard costs of debt relief policies.

In microfinance, one factor that works against the widespread use of default as de facto debt relief is the loss of social capital that occurs when non-repayment is publicly observable (Banerjee, 2013; Gine and Karlan, 2014; Diep-Nguyen and Dang, 2020). In the context of our model, this would correspond to a higher non-pecuniary cost ( _σ_ ) of default. For this reason, even microfinance lenders that have moved away from traditional group lending in favor of individual liability loans often still retain regular community meetings to raise the perceived cost of default.

## **3.2 Debt Forbearance**

Debt forbearance refers to policies that allow borrowers to postpone loan repayments for a given period of time without incurring penalties or a negative entry on their credit record, while leaving the amount of debt outstanding unchanged. Historically, forbearance has often been employed on an ad hoc basis in response to economic downturns in which a large number of borrowers face liquidity constraints and the nature of the underlying shock is thought to be transitory.

> 6 There is also a lack of comprehensive cross-country data on debt relief programs. One notable exception is the World Bank “Covid-19 Finance Sector Policy Responses Database”, which contains information on financial support programs worldwide and includes information on debt relief programs.

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