Submitted to:

Dr. A. N. Vijay Kumar

IIPM, Bangalore

Submitted by:

Anjali Roy

10PGDM –ABPM35

Abstract

Microfinance is a type of banking service that is provided to unemployed or low-income

individuals or groups who would otherwise have no other means of gaining financial services.

Ultimately, the goal of microfinance is to give low income people an opportunity to become self-

sufficient by providing a means of saving money, borrowing money and insurance. And

delinquency (a situation that occurs when loan payments are past due) is a major issue in Micro-

finance. Is one of the killers of microfinance institutions. Success for a Micro-finance institution

(MFI) starts with proper delinquency management.

International best practice for microfinance suggests that sustainability is an attainable goal

for microfinance institutions. Delinquency Management and Control are the critical issues

affecting the goal of sustainability for microfinance institutions.

Based on the premise that microfinance institutions (MFIs) have to be sustainable for long-

term impact, the Delinquency Management is important for MFI managers: So it’s very

important to analyze the causes of delinquency and reviewing the costs of delinquency to the

microfinance institutions so as to control delinquency to achieve a sustainable business.

The need of the hour for credit card issuers and banks is the pro-active identification of

potentially delinquent accounts at the earliest opportunity, and in a real-time environment. Credit

card issuers and Retail banks are increasingly looking at solutions that would deliver relevant

delinquency related information for intelligent management of delinquencies before they are

converted to full-blown defaults

Table of contents

S. No. Particulars Page No.

1 Introduction

2 Delinquency in microfinance

3 Effect of delinquency in microfinance

4 Measuring delinquency in microfinance

5 Causes of delinquency in microfinance

6 Preventing delinquency in microfinance

7 Acting on delinquent clients

8 Conclusion

9 References

1. Introduction

Micro Finance in India - An Overview

In the post nationalisation era, the banking sector witnessed flow of substantial amount of

resources while the banking network underwent an expansion phase without comparables in the

world. Credit came to be recognized as a remedy for many of the ills of poverty. Credit packages

and programmes were designed based on the perceived needs of the poor. Programmes also

underwent qualitative changes based on the experience gained. Besides the programmes initiated

by the Central Government, a large number of credit-based programmes were introduced by the

state governments with large resource allocations.

NABARD, during the early eighties, conducted a series of research studies in association with

MYRADA (a leading NGO from South India) and also independently which showed that despite

having a wide network of rural bank branches that implemented specific poverty alleviation

programmes and self-employment opportunities through bank credit for almost two decades, a

very large number of the poor continued to remain outside the fold of the formal banking system.

These studies also showed that the existing banking policies, systems and procedures, and

deposit and loan products were perhaps not well suited to meet the most immediate needs of the

poor. It also appeared that what the poor really needed was a better access to these services and

products, rather than cheap subsidised credit. Against this background, a need was felt for

alternative policies, systems and procedures, savings and loan products, other complementary

services, and new delivery mechanisms, which would fulfil the requirements of the poorest,

especially of the women members of such households.

The launching of its Pilot phase of the SHG (Self Help Group) Bank Linkage programme in

February 1992 could be considered as a landmark development in banking with the poor. The

SHG-informal thrift and credit groups of poor came to be recognised as bank clients under the

Pilot phase.

The strategy involved is simple viz. forming small, cohesive and participative groups of the poor,

encouraging them to pool their thrift regularly and using the pooled thrift to make small interest

bearing loans to members, and in the process learning the nuances of financial discipline.

Subsequently, bank credit also becomes available to the Group, to augment its resources for

lending to its members. It needs to be emphasised that NABARD sees the promotion and bank

linking of SHGs not as a credit programme but as part of an overall arrangement for providing

financial services to the poor in a sustainable manner and also an empowerment process for the

members of these SHGs. NABARD, however, also took a conscious decision to experiment with

other successful strategies such as replicating Grameen, wholesaling funds through NGO-MFIs.

2. Delinquency in microfinance

Delinquency management is a major issue in Micro-finance. Success for a Micro-finance

institution (MFI) starts with proper delinquency management. All staff in one MFI must be

trained on delinquency management. From the field to the top management and trustees,

everyone must be able to understand the mechanisms of delinquency and manage it.

Delinquency management is a skill. It can be learnt like any other skill. Learning how to manage

delinquency begins with understanding what is delinquency, its origins and consequences on the

organization. Monitoring delinquency is a part of this skill also. Micro-finance staff must be

trained on delinquency management from the very beginning, once they enter a MFI. Policies

and procedures in any MFI must be designed in accordance with proper delinquency

management practices.

What is Delinquency?

The situation that occurs when loan payments are past due. Also referred to as arrears or late

payments, measures the percentage of a loan portfolio at risk (USAID). Delinquency occurs

when one loan payment is one day late

Zero percent delinquency is an obtainable and a reasonable goal but requires the commitment of

the whole agency. Acceptance of a delinquency level above zero percent is the decision of the

institution itself and is a decision that has its own costs.

International standards definitions of delinquency

Delinquency is the situation that occurs when loan payments are past due (CGAP).

A delinquent loan is a loan on which payments are past due (Cal meadow).

Delinquent payments are loan payments which are past due.

Delinquency occurs when one loan payment is one day late.

Delinquent payments/payments in arrears are loan payments which are past due; delinquent

loans are loans on which any payments are past due. (adapted from SEEP)

3. Effect of delinquency in microfinance

It’s very important to identify the effect of delinquency in Micro-finance to understand the

importance of minimizing delinquency in Micro-finance.

This section discusses the consequences of delinquency on a Micro-finance institution. It

presents the different effects of delinquency on several issues related to the operations of a

Micro-finance institution. It highlights how the level of delinquency reveals the developmental

approach of one MFI.

Mohammed Yunus is professor of Economy from Bangladesh. He created in the 70s the

Grameen bank in Bangladesh. He is one of the pioneers in Micro-finance. Some refer to him as

the father of Micro-finance. He was one of the first one believing in the possibility to lend money

to very poor women to help them to start and operate an income generating activity. The

Grameen bank is now one of the biggest MFI in the world. Its methodology has been replicated

in a lot of countries including the Philippines. Grameen methodology relies on the constitution of

groups of poor women. The complete logic of M. Yunus is that “Credit without strict discipline

is nothing but charity. Charity does not help to overcome poverty. Poverty is a disease that has a

paralyzing effect on mind and body. A meaningful poverty alleviation program is one that helps

people gather will and strength to make cracks in the walls around them’

Mohammed Yunus implies that a strong sense of discipline in credit will give to the poor

beneficiaries of a poverty alleviation program the habits to be disciplined in their life.

Mohammed Yunus think that discipline is synonymous with will. He believes that the will is the

main strength poor people have to improve their living conditions.

Effects of delinquency

Delinquency is the biggest threat in Micro-finance: it threatens the long term institutional

viability. It questions the survival of the organization and the poor. The major effects of

delinquency in MFIs are following: (Costs of Delinquency and Default)

Delinquency is expensive for an MFI. It affects a program by:

Slowing rotation of portfolio

Loss of confidence in the organization for good payers

Demotivation in the MFI staff

Causing program to lose credibility

Delaying of earnings

Less time to promote and grant loans

Increase in collection costs and recovery operations

Decreasing operation spreads (less time to promote)

Leading to ever-increasing repayment problems

Threatening long-term institutional viability

4. Measuring delinquency in microfinance

Having measures of delinquency is necessary to act on delinquency. Understanding the meaning

of indicators is the basis to analyze the causes of delinquency and design the appropriate answer.

So here we will deal with the indicators that measure delinquency and how to use these

indicators to manage delinquency.

Quality of loan portfolio

The outstanding portfolio of a Micro-finance institution is defined as the principal amount of

loan balances outstanding. In other word, it is the remaining balance in principal of all the

outstanding loans.

The outstanding portfolio is the main asset of an MFI. This is the outstanding portfolio which

generates income with interest and fees. It is also what the clients are demanding. As a

conclusion, it is the reason for existence of one MFI. Assessing the outstanding portfolio can be

done in two ways: quantitatively and qualitatively.

Quantitative measure of the outstanding portfolio means measuring the size of the portfolio. It is

expressed with an amount given in a specific currency.

Qualitative measure of the outstanding portfolio means measuring its capability to generate

income. In other words this is the financial efficiency of the money lent to clients. An

outstanding portfolio which contains a lot of bad debt is not a qualitative portfolio. A bad debt

corresponds to loans that are late. A loan with late payments is a bad debt as it has less chance to

be fully paid by the clients. A loan with late payments is a risky loan. The bigger the number of

late payment, the higher the risk not to be paid for the MFI. The higher the number of mys-

payments, the lower the quality of the portfolio. Measuring the quality of the portfolio is the best

measure of delinquency as it measure the risk not to be paid.

Measuring the loan portfolio quality can be done with ratios. Ratios allow you to examine

financial relationships to diagnose the well-being of your institution. Key ratios should be

monitored regularly to measure performance. PAR is the best indicator for assessing the risk of

potential losses. Arrears rate overestimates portfolio quality

Although PAR is the best when looking at portfolio quality, it is difficult to apply to village

banking schemes that accept partial payments. The institution makes the loan to the village bank

as a whole and often does not track individual clients. PAR also has limitations for rapid growth

portfolios and will be lower after adjusting for write-offs. This may mask institutional lending

problems.

The following table shows the purpose of each indicator and gives a range of acceptable ratios.

Performance Ratios and Loan Portfolio Quality

Indicator Ratio Measurement

Portfolio at Risk(PAR)By Age

unpaid principal balance of all loans with at least 1, 30, or more days past due

outstanding portfolio

Answers the question “How much could you lose if all late borrowers default?” Portfolio aging separates more risk loans from less risky. (The longer a loan goes unpaid, the higher the risk it will never be paid.)

Arrears RatePast Due Rate

amount past dueoutstanding portfolio

Answers the question “How commonplace is non-payment?” Measures amount of loan principal that is due but not paid.

Repayment rate amount received (current and past due)

less prepaymentstotal amount due this period + amount

past due from previous periods

Shows amount paid compared to amount due or expected during a specific period. Does not provide useful information about the performance of the outstanding portfolio.

Current recovery rate

amount received this period (P or P+I)amount due this period (P or P+I) under

original loan terms

P = Principal I = Interest

Fluctuates from month to month.Is meaningful only for longerperiods. Can be processedalgebraically to predict eventualloan loss rates.

Annual loan loss rate

amt of loans written off as unrecoverableaverage outstanding portfolio

Annual cost of default, whichmust be balanced by higherinterest income.

Other indicators measuring of delinquency are also currently used:

Repayment rate = amount received (less prepayments)/total amount due this period (including

past due from previous period). It shows the amount paid compared to the amount expected. It is

a measure of the MFI capability to be paid on time.

Repayment ratio on maturity = amount received on maturity date/total amount due. It shows

the amount paid compared the amount expected to be paid on maturity. It measures the capability

of a MFI to be paid on time, on maturity. In other words it measures the capability of the MFI to

make the clients respect their contract. When a repayment rate is computed on maturity, there is

no longer prepayment as all payment are due. Furthermore, the total amount due is equal to the

amount lent to the borrower, as all payments are due.

% Non-past due clients or % past due clients: it helps to understand if my delinquent clients

have big or small arrears. It shows how the delinquency is spread among the clientele. In other

words, it shows how far the delinquency is a common practice among my clients.

Arrears rate or past due rate = amount of arrears or past due/outstanding portfolio. It gives an

indication on how common is non-payment within my portfolio. Arrears rate is usually smaller

that portfolio at risk as it consider only the late payments and do not consider the remaining

balance. The amount of late payment is just a part of the remaining balance.

Collection ratio: this ratio might have been quoted by the participants. Collection ratio gives the

opportunity to the management to assess the collection performance of the field staff. But this

ration does not give a precise assessment of the delinquency level within the MFI. It shows that

improvements might be necessary in the collection performance. It is mainly a managerial tool. It

serves also as a cash-flow planning tool. Based on the average performance in collection, the

MFI can plan the amount of cash that will be collected regularly.

5. Causes of delinquency

Understanding the causes of delinquency helps to design the appropriate answers to delinquency.

It helps also to determine the acceptable level of delinquency in one MFI. So this section will

deal with identifying the reasons of delinquency, understanding the clients’ motivation to

become delinquent and identifying which factors are controllable and which are not.

Ultimately the microfinance institution itself is responsible for delinquency (even when the

proximate cause seems external to the MFI) because it sets its own principles, promotes its own

repayment culture, instills credit discipline in staff and borrowers, and must plan for events

beyond its control. There are many stakeholders in delinquency, but only the MFI can do

something about it.

Uncontrollable factors in delinquency - are factors that do not depend on the MFI or on the

clients.

• Natural disasters: as earthquakes, floods, fires.

• Changes in government policy: new tax, crackdown on street vendor.

• Individual crisis: illness, death in the family.

• State of local, national or world economy: financial crisis in South-East Asia.

Factors such as these require constant monitoring and consideration. While the MFI may not be

able to control them, they can influence the quality of the portfolio. The MFI should be able to

compensate for them in its design, methodology and collection procedures.

In late 90’, huge floods had tragic effects in Bangladesh. Many of the Grameen bank clients lost

everything. The MFI had to adjust its policies to face the issue. Indeed, Grameen granted new

loans for their clients who lost everything. These loans aimed at helping their clients to re-start

an activity. Some MFI advocate with governments in order to influence them to take measures

in favour of their clients. Thus the legal framework can be improved for poor people operating a

small business. Example: allowing street vendors to operate.

MFI can also provide services that reduce the vulnerability of their clients in front of individual

crisis. A Micro insurance scheme is a good tool to reduce the vulnerability of MFI’s clients for

death or diseases. MFI can also linkage with other NGO that provide other services to reduce the

vulnerability of their clients: linkage with social programs or health programs. This entails a

close coordination at the field level.

Controllable factors- Controllable factors are numerous. Among the controllable factors, the

following can be identified.

• Methodology

• Behavior or knowledge of staff

• Value/image of MFI

• Organization of work / management

The identification of the precise reasons for delinquency is very important as it will

determine the solution that must be found. Understanding the root cause of delinquency is also

the most difficult as it implies to assess all the MFI: its organization, its methodology, its image,

the capabilities of its staff, etc.

Conclusion on the causes of delinquency- Most factors are controllable. Very few factors are

uncontrollable. There are no bad borrowers but MFI that do not implement an effective

methodology or are not well organized. Identifying the precise causes of delinquency for a MFI

is a necessary step to address it.

6. Preventing delinquency in microfinance- Prevention is better than cure

This topic will deal with the ways to avoid delinquency before it occurs. Preventing delinquency

is an issue that needs to be separate into several sub-issues. So we have to understand the key

issues for effective prevention of delinquency and have to enumerate solutions to prevent

delinquency based on the key issues.

Key Elements of Delinquency Prevention

• Understand the causes of the problem before developing a solution

• Program’s image and philosophy

• Methodology

Borrower selection

Loan size and terms

Incentives

• Information Systems

Reliable, accurate and timely data

Relevant detail for level of use (BOD, Mgmt, Staff)

Relevant and timely dissemination

Cost-effective

Delinquency is caused by MFIs that have not implemented an effective methodology; MFIs need

to discipline borrowers and create an image of being intolerant of late payments; Loan sizes and

terms should not make repayment difficult.

7. Acting on delinquent clients

Acting on delinquent clients means implementing actions to motivate them to pay back. This

section deals with actions that can be implemented once clients became delinquent. It stresses the

necessity to have specific approach to handle delinquent clients. It proposes different contents for

discussion to motivate delinquent clients to re-start their payments.

Several kind of action can be taken:

Legal action: MFI can request legal authority to put pressure on their clients (example:

Barangay or court). These actions can be very efficient but they are most of the time very costly.

They are barely implemented. To be efficient, these actions must be standardized and systematic.

Most of the time, these actions are taken when all other actions failed.

Internal process: MFI can have a set of standardized action to be taken in case of delinquency.

Managers or specialized staff can visit delinquent clients as a new face with more authority is

often more frightening for a delinquent. Notices can be sent also. In order to be efficient, these

internal actions must be systematic and standardized.

Direct client motivation: motivating delinquent clients to pay is one of the hardest part in the

work of field staff. They have to be prepared to handle this situation. Some staff are “naturally”

good in it. Nevertheless, this skill can improved. First convincing arguments must be identified.

Managers can help staff to improve their convincing skills by coaching them. Training with play

role can also help a lot. Convincing argument can be split into two categories: “those which

remind the benefits to pay on time” and “those which remind the cost and risk of being

delinquent”. For most clients, convincing arguments will be enough to motivate them to pay. The

difficult part of the job is to find which will convince them. It is advisable to start with trying to

motivate positively delinquent clients, reminding them the benefits. Then costs and risks can be

enumerated. Of course, to be efficient, internal process that can follow this one-on-one

discussion must be properly implemented to prove delinquent clients that the costs and risks are

real.

Example of benefits that can be reminded:

• Accessing other loans (with possible bigger amount).

• Accessing to other services (training, counseling)

• Positive reputation among peers &

• Lower interest

Example of costs and risks that can be reminded:

• Additional interest

• Pressure from the group or neighbor/bad reputation

• Legal action

Benefits and cost to clients for on time and late payments

On time payments Late or no payments

Benefits

for

clients

Probability of immediate larger follow up loans

Development of positive credit history

Positive reputation among peers Access to training, savings or

other program services Access to advice from credit

officers Award or prizes for timely

repayment. Lower interest rates on second &

third loans Interest rebates

Lower expenses if interest payments not made

Maintain capital (or portion) from loan in business or use for other purposes

Fewer or no trips to financial institution to make payments (lower transaction costs, in case of branch or area collection)

Lower transaction costs of attending meetings and other activities of lending institution

May not have to repay at all, if there is a low cost to default

Cost for clients

Pay interest and capital on current loan

Pay time and transportation costs to make payments

Opportunity costs (if time is spent

Late fees for late payments Delay future loans or loss of

access to future loans Possible legal action and costs Possible loss of collateral

in meetings, it prevents the clients from working on his/her business).

Loss of access to other program services

Hassle of frequent visits by loan officers

Hassle of pressure from group members if group loans

Negative reputation among peersThe MFI must understand what are the borrowers’ perceptions to design appropriate process for incentives.

iGATE Patni Pre-Delinquency Management (PDM) Solution

The Pre-Delinquency Management solution offering from iGATE Patni enables pro-active credit

risk mitigation through identification of potentially delinquent customers/accounts before they

actually turn delinquent.

The PDM solution is built on proprietary transactional scoring and behavioral scoring models.

The solution undertakes both peer-to-peer comparative analysis & customer behavioral analysis

to proactively identify and analyze potentially/habitually delinquent accounts and customers.

Unique features of PDM Solution- The unique features of iGATE Patni's PDM solution

include:

Transactional analysis of potentially delinquent accounts to assess credit orientation and

credit worthiness

Integration of credit scoring intelligence with pre-delinquency assessment

Objective, intuitive and comprehensive set of practical business rules based on different

transactional modes, patterns and types

Enables application of separate sets of rules for different customer classes/groups based

on various customer segmentation modes/models

Ability to create and customize business rule sets to suit the particular credit profile and

risk aspects of specific groups of customers

Allocation of different weights to specific business rules applied to each customer group

offers the optimal flexibility to define delinquency assessment models as per the credit

profile and transactional profile of underlying customer segments

Delinquency assessment to be undertaken without impeding transactional analysis

8. Summary: Delinquency Causes and Controls

- Accept that most delinquency is caused not by bad borrowers but by MFIs that have not

implemented an effective methodology.

- Create an image and philosophy that does not consider late payments acceptable. The

benefit of creating disciplined borrowers is critical to the success of the micro finance

institution.

- Clients must value the credit service. Loan products should suit clients’ needs, the

delivery process should be convenient, and clients should be made to feel that the

organization respects and cares about them. Incentives won’t work if the clients do not

value the access to the credit.

- There are no bad borrowers only bad loans. Make sure loan sizes and terms do not make

repayment difficult. Do not base loans on projections, base on capacity to repay.

- Establish an incentive system that uses both financial and non-financial incentives to

encourage on time repayments. For the borrower these can include larger loans, follow up

loans, interest rebates, and access to training (or disincentives—penalty fees, no further

access to loans, collection of collateral, legal action.)

- Design an incentive system for the field staff/loan officers that include on-time payments

as an important variable. An incentive system places the responsibility for portfolio

quality on the shoulders of the loan officers who with support can best respond to

repayment problems. It can motivate officers to look for and eliminate the causes of

arrears.

- Ensure that from the borrowers’ perspective the benefits of on time repayment and costs

of late repayment far outweigh the benefits of late repayment and costs of on-time

repayment.

- Develop systems that provide information to field workers that enable them to conduct

effective and timely follow-up of loans and to manage their portfolios efficiently. The

easier it is for the field staff to figure out whose payments are due and when, who is late

and by how much, the more time they can spend with borrowers.

- Develop a portfolio information system that enables management to conduct timely and

useful analysis of portfolio quality, determine trends in the portfolio over time, and

identify possible causes of delinquency.

- Effective delinquency follow-up procedures are needed. Develop policy that lists the

steps one takes when a loan becomes past due. Examples included activating the group to

follow up, visiting clients, holding frequent staff meetings to discuss problem loans, etc.

- Establish a target level of acceptable delinquency based on thorough understanding of the

costs and effects of delinquency on the program. Establish prudent loan loss reserves and

write off policies. Ensure that income and assets are accurately reflected in the financial

statements.

9. References

- PDF on “Delinquency Measurement and Control AND Interest Rate Calculation and

Setting”, CGAP.

- Report on “Delinquency Management and Interest Rate Setting for Microfinance

Institutions”, 2009, CGAP

- “Delinquency management Training manual”, prepared by Gregory DOUCET, Urban

Program for Livelihood Finance and Training (UPLIFT), May 28, 2004 Version

- Report on “Measuring Microcredit Delinquency: Ratios Can Be Harmful to Your Health”

June, 1999 Richard Rosenberg, CGAP

- Websites

- www.investopedia.com

- www.wikipedia,com

- www.nabard.org

- www.grameen-info.org

- www.microfinancegateway.com