Key Topics in Microfinance Management – Day 2
Don Johnston, MAXIS Program Manager for Indonesia
April 2008
Course Overview
Day 1: The Mission of Microfinance – Experience and Potential in Indonesia
Day 2: Day 2: Managing Credit Risk Managing Credit Risk – – A A Fresh Look
Fresh Look
Day 3: Supervision and Replication of MFIs
Day 4: The View from the Top – Effective and Efficient System-wide Management
Day 5: Microfinance Institutions and their
Customers – The Case of the BPRs
Day 2: Managing Credit Risk – A Fresh Look
Session 1: Session 1: Managing Credit Risk Managing Credit Risk Before Loans are Made
Before Loans are Made – – Product Product Design, Pricing, Marketing and
Design, Pricing, Marketing and Borrower Assessment
Borrower Assessment
Session 2: Managing Credit Risk post-
Disbursement: Monitoring, Collection, and
Planned Response to Non-Repayment
Credit Product Design
Bad Design = High Risk!
Do Your Homework!
Set the Product Characteristics
Add Motivation Tools
Credit Product Design Do Your Homework!
Know the Customer Need
How will they use the credit?
Know the Main Source of Repayment
How will they repay?
Know the Range of Reliability among Customers
Character (Willingness and Self-Discipline to Pay on Time)
Risk over Time
Know the MFI’s Sources of Funds
Know the MFI’s Level of Technology
Interest Calculation – Automated or Manual?
Information on Future Payments – Automated, Flexible?
Credit Product Design
What Does the Customer Need?
We Need the Real Story!
Modal kerja usaha – musiman, “tetap”
Investasi usaha – aktiva tetap
Modal kerja atau investasi untuk usaha lain
Pembiayaan konsumsi atau investasi rumahtangga
Dana Darurat
Credit Product Design
Set the Product Characteristics
Disbursement Schedule
1x or in Steps
Repayment Schedule or Schedules
Assessment Method
AO, Group, or AO + Group?
Repayment Method
Pay in office or Collect “on the spot”
Monitoring Method
Standard Monitoring Reports, Standards for Visits and Loan Review
Pricing Method
Pricing Level
Credit Product Design
Alternatives in Pricing Design
Flat v. Effective Rate: Why use a flat rate?
Transparency in payments – easy to explain
Some advantages in bookkeeping
Makes interest rate numbers look lower
Fixed v. Variable Rate:
Advantages of a Fixed Rate for micro borrowers
Fees & Commissions
Pre-paid Penalties: (the incentive for timely repayment)
Compulsory Savings: What does it do?
Up-Front Interest
Interest v. Profit/Revenue Sharing
“Presumptive Profits”
Syariah v. Conventional Basis
Credit Pricing
What is the Profit Objective?
Achieve Sustainability/Profitability
Focus on Costs + Margin
Achieve Outreach/Growth
Focus on Market (customer preferences, growth potential, competition)
Satisfy Regulatory Requirements
Focus on Pricing Model
Help People Improve their Lives
Focus on Keeping Rates Low
Credit Product Design Add Motivation Tools
Incentive to Pay on Time
Account Officer Incentives
Customer Education Plan
Informal or Training for New Borrowers
Repeat Loans, Consequences of Non-Repayment
Collateral
Collateral
Collateral is not a substitute for assessment!
Collateral as a sign of character, confidence
If the borrower has an asset acceptable as collateral and will not commit, would you lend to him/her?
Try not to receive collateral (costly, time-consuming)
“friendly” sale of collateral asset to pay off loan
Collateral can be a security blanket to avoid analysis.
Only time actually take collateral is when the borrower can pay but is trying to get away with non-repayment - make an example.
At MFI, Collateral = Possession of Ownership Document, Not Formal Registration
Collateral Types
Accept as collateral the assets that people in the target market own
land (may be untitled, accept lesser proof of ownership)
vehicles
household or enterprise furniture/ equipment/ appliances
The bank is not a pawn shop
Less formal collateral forms may require more “public”
involvement
Collateral “Substitutes”:
Co-signing, Personal Guarantees, Recommendations from village officials or local figures, Group Credit
Are they knowledgeable, and will they will help collect?
Collateral: Questions for Discussion
At the micro level, is collateral necessary? Is it useful?
Micro-entrepreneurs may not have traditional collateral
Is group credit a good substitute?
What about guarantors?
Credit Marketing
Encouraging High-Quality Applicants
“The Right Product at the Right Price at the Right Time”
Institutional Image
Local Knowledge & Direct Marketing
Î Genuine Demand
Î Self-Selection by Potential Borrowers
Î Borrowers want to be Your Customer!
Î Professional-looking Staff
Î High-quality brochures, etc.
Î Know which recommendations are trustworthy
Î Informal Pre-Screening – AOs need to talk to lots of people!
Î Meetings & “Training”
Î Formal pre-screening, pre- qualification
The Application Process
Initial Knowledge
First Contact: Informal Discussion
Formal application
Begin accumulating required doc’s
Field visit, assessment (may include group
recommendation)
Recommendation by loan officer
Loan Approval
Disbursement
Î From marketing, other customers
Î Pre-screening, self-selection
Î Standardized basic data form
Î Incomplete doc’s a source of delay
Good Micro Loan Assessment: Fast, Efficient, Effective
Micro borrowers need fast decisions
Micro lenders need efficient assessment &
decisions
Loan officers have many competing claims on their time
BUT . . .
High losses are fatal – choosing good
borrowers is crucial
Critical Information for Assessment Ability to Repay
Current cash flow, repayment ability prior to receiving a loan, or
Expected increase in profit which will result if the borrower uses the loan proceeds to
expand the existing enterprise as agreed
Key Decision – Which to rely on?
Critical Information for Assessment Willingness to Repay
Two Key Questions
Is the borrower a reliable debtor?
How much “reminding” do they need to pay on time?
Functional definition of “Character,” not a moral judgment
Everyone needs to know the consequences of non-repayment, late payments
Most borrowers need to know they’re being
monitored (fast response to late payment)
Critical Information for Assessment The Life Stage of the Firm
Stage 1: Start-up
Stage 2: Expansion
Stage 3: Transformation
Assessment mostly the same at each stage
However, . . .
Emphasis varies
Current cash flow v. future projection
New v. established visit or New Entrepreneur
may be too difficult to obtain needed information for some, esp. for start-ups by new entrepreneurs (Double Start-ups)
Expansion Lending: The Mainstay of Microfinance
At the MFI Office, check whether applicant has had a previous loan
Repayments on time?
Size of loan requested compared to previous loans
Can set personal loan limit (e.g., up to double loan size if paid all installments on time on previous loan) - but not automatic. Danger of over crediting
Critical Information for Assessment Site Visit: The Enterprise
Go to the business location - talk with entrepreneur.
Watch the entrepreneur dealing with customers.
Look for information on:
technical skill
management skill
knowledge of market
Supply arrangements, other borrowing
Special attention to possibility of expansion in present market (expansion or transformation?)
See items pledged as collateral (may require home visit, too)
How to contact if not available at business
Assessment: The Site Visit
Enterprise Financial Information
Likely that will not have formal set of books - profit and loss, balance sheet, etc. May have a cash book - transactions in and out.
Find out turnover - sales during a one week, two week etc period.
Is cash flow regular or irregular? This will be used to match with repayment schedule
Assessment: The Site Visit
Debt and Personal Finances
Other sources of income
remittances from working children in city
renting out land
other employment & family enterprises, etc.
Other expenses or payment obligations
Loans
Large bills due (e.g., hospital)
Support of additional member of family
Non-routine school fees (child entering school)
Savings – financial cushion
May require a home visit (if different location)
Loan Analysis
Construct a simple profit and loss statement on present turnover and size of operation.
If the enterprise will use the loan to expand, what
would be the increase in volume, sales, profit - gross above expenses which also expanded?
Probably apply rule of thumb:
If loan use as discussed, loan repayment should not take more than 75% of increase in profit, or
Payment should not be greater than 50% of total profit, or
Expansion during the loan period should not double the firm’s present size (transformation)
Character Check
Walk around village and talk to people.
In Indonesia, the village head usually knows if the applicant has other loans, payment of land tax – anything that will get discussion.
When talking to other villagers, look for indirect or non- verbal cues.
Group Recommendations (if applicable)
Recommendations from other Customers
Signed statements from officials or politicians that the applicant is reliable are not worth much. (BKK story – one village head always signed but had a secret mark which meant “don't loan this person money”)
Over time, the loan officer will develop contacts and know the reliability of information
Ensuring Good Assessments
Ability of the Loan Officer
Job-focused Training
Accountability
Pros and cons of separation of marketing, decision-making, collection
Incentives and Career Path
Close Supervision from managers & supervisors
Decision support tools
Horizontal communication
Policy toward unusual/niche sectors
Start-Up & Transformation Lending
Start-ups (how new? - Other enterprises?)
Example: applicant has worked in garage for other person, now wants to start on own - has technical skill, question of management ability (check knowledge of prices etc )
Probably best avoid start-ups if really new - no previous experience, no one to guarantee
Transformation Lending
Market knowledge
Marketing – e.g., agreement with shop, etc.
Beginning of need for some separation of tasks
Assessment
Questions for Discussion
In your experience, which is more important to make good Account Officers: training or experience?
How long does it take to make a good Account Officer?
What kinds of information are hardest to
obtain? What are your strategies?
Day 2: Managing Credit Risk – A Fresh Look
Session 1: Managing Credit Risk Before Loans are Made – Product Design, Pricing, Marketing and Borrower Assessment
Session 2: Session 2: Managing Credit Risk Managing Credit Risk post post - - Disbursement: Monitoring, Disbursement: Monitoring,
Collection, and Planned Response to
Collection, and Planned Response to
Non Non - - Repayment Repayment
“A Pound of Prevention . . .”
Preventing Problems is more cost-effective than responding.
But
Loan Officer must monitor many borrowers
No time to visit every borrower even once a quarter What to do?
First, attract and choose good borrowers
Monitor repayment closely (installment loans are easier)
Concentrate on loans with problems - "Manage by exception"
Intervene early – and develop an image of close monitoring and early response!
Monitoring of Individual Loans
Installment product makes monitoring easier (clarity about size and timing of payments falling due)
Clear payment due dates and definition of on-time payments (incentive for timely repayment reinforces the due dates,
promotes good payment behavior)
Loans can be booked throughout the month
(less “bunching” of loan due dates – matters both for smoothing workload and speeding response time)
System reports payments which will fall due soon (very important for loans with less frequent payments)
Daily reports of overdue payments to loan officer &
manager/supervisor
What Next?
Early Response to Late Payments
Immediate reaction if an installment is late
Visit the delinquent borrower within one day if possible - always within one week
Understand why the installment is late
Get signed promise to pay according to detailed schedule
One visit should be enough in most cases
If additional visits are required, Unit Head or even Supervisor may accompany
Close monitoring of commitments to pay
Reinforce the image of close monitoring, but do not be too tough, overbearing
Why Borrowers Fail to Pay on Time
People sometimes forget or just run late
Educate, remind about incentive to pay on time
Show you’re watching
Main reasons for non-repayment
family emergency
lack of savings as financial cushion
Work it out, new schedule, etc. (all informal)
Try not to take collateral, especially home / house plot
A few late borrowers have the funds but don’t want to pay
Requires strong and immediate action
Depending on steps, this can be very expensive, time-consuming, but
If these are allowed to get away with it, portfolio can "tip," destroying the lending institution
Collecting from the Unwilling:
The Best Approach
Collecting from the Unwilling:
Some Strategies
Plan policies and responses ahead of time
escalation steps
cultural susceptibility to shame
involvement of outside parties
strategic use of collateral documents
legal, community approaches
Budget for legal and collection activities
Questions for Discussion
Marketing and Monitoring
Does image matter for MFI lending? What image does a good MFI want?
How does your MFI build up its image? In what ways do you think it needs to improve?
How do you tell your customers about:
The importance of paying on time
The consequences of non-repayment
