Vol 10 (2013) - Issue 1

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Personal Insolvency: Next Step for Reformers in Developing Countries

Where it is available in developed economies, personal bankruptcy is a regular vehicle for failed businesses when those businesses are sole proprietorships, or even small businesses with identity non-separable from their owners/proprietors. In the context of developing countries, where a large proportion of businesses are small and comprised of sole-proprietorships, where self-employment is common in the face of limited opportunities for lucrative employment, a personal bankruptcy system becomes important to maintaining a welcoming business climate, particularly for entrepreneurs. Without a system for personal bankruptcy, individuals who start a business, but fail, can be burdened with the debts of a failing business for a lifetime, preventing redeployment of their 'human capital' back into productive economic use. Personal insolvency has macroeconomic implications as well, and these are also discussed. While there is significant scholarship on the nature of personal insolvency issues and business climate, to date reformers in developing countries have not addressed this area. The time is ripe to address integrate personal insolvency into investment climate reform.

I. Introduction: Reasons to encourage systems for resolution of personal/household debt

The idea of personal insolvency as a development initiative is not a novel one, though it has not been pursued aggressively in donor-funded development/ reform programs. The focus of most restructuring/ bankruptcy reform is still on corporate/business bankruptcy. However, it appears that personal insolvency issues are gaining increasing attention.
On a micro level, individuals who start or operate businesses, or are self-employed, often finance their work or business with personal debt. When the business or endeavour fails, they can be left with burdensome debt that can hamper their ability to recover and reenter the marketplace, without a system that allows restructuring, relief from burdensome debt, and a fresh start. This is true in developed and developing countries. However, in developing countries, sole-proprietorships, or small or micro-business, which are indistinguishable in identity from their owners/proprietors, are ubiquitous. Often there is less opportunity for wage-earning, and the economy and its risk factors result in a heavy proportion of small, one-person or one-family operations. It is these countries that arguably most need the release valve of a personal bankruptcy system, to allow such entrepreneurs and self-employed individuals to recover and reenter the economy, that fail to provide personal bankruptcy mechanisms. As credit availability increases for individuals across the globe, and more economies support entrepreneurship, assisting developing countries in developing personal insolvency systems is a natural evolution of the business climate reform portfolio.
Personal insolvency also reaches beyond individual debtors and their particular situations. The existence or the lack of a system for discharge of personal/household debt has macroeconomic implications. In fact, the IMF has issued an IMF Staff Position Note, dated June 26, 2009, suggesting that a system for restructuring of individual debt is important for countries facing financial crisis in order to prevent further drain on the economy that could lead to social unrest. As a systemic issue, as consumer credit increases in developing countries, a personal insolvency system is an important check on the financial stability of individual borrowers, and the discipline of the institutions that lend to them.