October 7th, 2009 at 5:50 am, V.Rengarajan ()

There could be two level analysis on micro loan asset for the locating the causes of default, in MFIs i.e., institutional level and client level. Although the former helps to identify the causes for the default syndrome, the latter could facilitate to locate the root causes as it is also functionally related with the former. It also reveals the causal relationship between the ‘collectability’ and capability of surplus income generation of the loan asset portfolios in a given environ at client level. This vital factor influences very much for the maintenance of human relations (loan officers/group leaders. and clients) and level of default as well both at institutional and client levels.

With this premise , a perusal of case studies referred to by Daniel Rozas reveal that by and large the causes for the default are related to (institutions) functioning of the staff (both executive and managerial ) and collection system at institutional level, except in the case of ICICI bank partnership model in India where the public/clients are misguided. for not repaying as reported… Albeit these facts are useful to observe the sordid state of affairs in the functioning of MFI, none of the case studies probed the root causes of the default syndrome in the actual functioning of micro loan asset portfolios at client level and its linkages with the institutional performance.
(In the case study analysis particularly on the MF institutions involved in micro credit activity if not Micro finance for the poor, how it is relevant to include Bank Dangang Bali of Indonesia whose clients are reported to be whole sale traders and merchants? Are these clients’ poor demanding micro credit?).

Coming to the functioning of micro credit asset analysis, it may be noted that ‘Collection process ’ cannot work in vacuum both at funding level (investor – MFI )and lending level (MFI- borrowers) as well… Micro credit is a high sensitive tool for poverty reduction demanding a deeper insights on its interaction with non monetary considerations at poor client level and also on the root cause for either income generation or of the default syndrome Despite a well built ‘collection mechanism’ supported with trained staff following rigorous system , there is also default risk. In such cases, crucial questions are -what are the basic factors ultimately which influence level of the default in the collection process? Is it possible to reduce or prevent ‘the default’ in the MF system at the client level itself? Is there any other factor other than human relationship (loan officer and borrowers /.group leader/) and collection system (institutional level) which cause the trouble? What are the contributory factors for this trouble in pre default stage or before default occurs? Probably for ‘nipping in the bud’ in the said syndrome, an analysis on pre sanction and post sanction of loan steps at the ultimate borrowers level may help to appreciate how these micro loans portfolio (asset) are potentially valued /securitized for income generation purposes and are protected against delinquency at client level. To elaborate further, at pre sanction of loan stage, the factor like capability of the borrower and physical environ for effective utilization , pro poor loan structure and repayment schedule, strength of economically potentials (infrastructure support) for income generation with surplus for repayment, most importantly protected under micro insurance(forgotten component of Micro finance) and capability for induced demand ( due to capability for expansion of the present income generation activity) for next loan, need to be tested. Similarly at post sanction micro loan, supervision of end use of micro loan, level of income generation, flexibility in repayment schedule for coping with idiosyncratic and covariant risk factors, marketing etc, need to be looked into.

To reiterate that if the well functioning of micro loan asset is ensured with a sustainable income generation at client’s level(candid symptom of poverty reduction), eventually, the ‘return/collection’ is ensured for both the borrowers as well the creditors, lender/investor making the collection process easy irrespective of the type of institution the ‘collection machinery’ belongs. It is irony even MF industry, knowingly or unknowingly ignored these fundamentals for micro financing and most of them ( both investors/creditors/lender) seldom know how their micro asset portfolios are performing as illustrated above at poor client level. It is highly unfair that this kind of unethical event happening even under MF platform while poverty is attacked with MF .Now they are ‘crying over the spilt milk’ (default syndrome) and face liquidation.

Some suggested measures for minimizing the default syndrome and addition of securitization values of these micro loans asset’. These experimental suggestions are meant for safeguarding micro loan assets of MFI in future and not as panacea for the failed MFIs.

Policy level – On the lines of Deposit insurance and Credit Guarantee corporation(DICGC) in India, Micro finance Deposit and Credit Guarantee Corporation may be experimented as it enable MFIs to make certain% of claim in the case of default under stipulated norms(60% claim under the DICGC in India for the mainstream banking) This guaranteed micro loan assets add security values and saleable or mortgageable values as well facilitating for conducive transfer services too.

Government may also consider extension of subsidy (for the poor clients) and refinance (for the MFI) to micro loan asset of MFIs (as extended to mainstream banks in India) so that liability would be lessened at borrower’s level and default risk minimized at institutional level.

Lending level- 1.Where ever possible ‘Tie up arrangement’ with marketing institutions for the MFI borrowers product for adjusting loan repayment installment from their sale proceeds and crediting to loan a/c of the respective borrower in MFI as collection.( In India for dairy scheme and sugarcane crop loan , a contract for tie up is being made with concerned dairy cooperatives and sugar mills for this kind of ‘collection’ at pre sanction of loan itself) 2. All the income generating assets created out of micro loan need to be insured (Micro insurance) as mandatory.(In India livestock, farm machinery for which micro credit extended need to be insured as mandatory in mainstream banks).

October 25th, 2009 at 2:53 pm, Daniel Rozas ()

Deb (and Rich) — thanks for your very helpful thoughts. I actually completely agree with the spirit behind your comments, in that care should be taken to prevent the potential negative effects of my recommendations from overshadowing their benefits. Frankly, I myself am unhappy with the recommendations — not because of their quality (which I stand behind), but because they are the product of a necessary policy compromise.

The ideal approach for dealing with MFI failures would be a strong government regulatory body dedicated to microfinance, that, among other things, would have the necessary expertise and legal authority to take over a failing MFI and either implement a restructuring/work-out, position it for sale, or wind-down operations in a measured way. The model I have in mind is the Federal Deposit Insurance Corporation (FDIC) in the US, though with extensive adaptations for microfinance. Having such a body could also produce the side-benefits of minimum lending standards, transparency, and client protection. Unfortunately, such an entity is unlikely to emerge anywhere in the foreseeable future — besides the high governance standards it requires, there is little domestic demand for it, and the only viable scenario under which I could imagine it emerging is when deposit-taking becomes the norm, and the subsequent concern for the safety of clients’ savings becomes the driving political force.

Since that’s not in the cards at present, the remaining option for dealing with a failing MFI is creditor action. As you suggest, this is an imperfect solution, and potentially fraught with downside risks. However, I’m not sure that these risks don’t already exist, and to make that point, I’d like to address each concern separately.

First, acceleration clauses are not uncommon — CGAP’s own guide to MFI loan agreements (http://www.microfinancegateway.org/p/site/m/template.rc/1.9.28341/) includes them. Might they be abused? Sure, but consider that an MFI investor is almost always better off keeping the investee functioning rather that pushing them into default, exactly because doing the latter is likely to lead to rapid deterioration in portfolio quality and probably the MFI’s inability to repay.

Second, the issue of director liability can be sensitive, but it is already an existing practice (see Stromme Uganda in the FOCCAS, WEEC, and SOMED cases). Also, this liability need not be unlimited — the amount should be sufficient to align their incentives with the lender’s, but certainly not to pay off the debt entirely. The recent executive pay issues in the US make me think that such an approach may not be unreasonable even for large financial corporations.

Finally, regarding the different legal claims of lenders — I never suggest to ignore them outright, but only 1) make the point that their legal claims are belied by their actual risk exposure and that 2) following legal claims too literally in a liquidation can hurt the very ones who insist on their legal rights — the FOCCAS case is an excellent demonstration of exactly that problem.

In general, these suggestions are not meant to be a one-size-fits-all template, but only very high-level outlines investors can use as roadmaps for the loss-mitigation part of their risk management.

Daniel

November 21st, 2009 at 9:20 am, financial and operations principal ()

financial and operations principal…

financial and operations principal. Remember that it takes time, effort and dedication, just like…

February 8th, 2011 at 2:32 am, SHISA ROBERT ()

This is the total of all the loans that a financial institution, or other lender, holds at a given point in time.