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: Managing Credit Risk A 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: Managing Credit Risk Before Loans are Made Product Design, Pricing, Marketing and 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 Genuine Demand Self-Selection by Potential Borrowers Borrowers want to be Your Customer! Professional-looking Staff High-quality brochures, etc. Local Knowledge & Direct Marketing Know which recommendations are trustworthy Informal Pre-Screening AOs need to talk to lots of people! Meetings & Training Formal pre-screening, prequalification
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 From marketing, other customers Pre-screening, self-selection Standardized basic data form 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 Emphasis varies However,... 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 nonverbal 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: Managing Credit Risk post-disbursement: Monitoring, Collection, and Planned Response to Non-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 How soon do your AOs know after a payment is late?