MICROCAPITAL.ORG STORY: CGAP Blog Explains High Collection Rates And Clarifies Key Microfinance Concepts Including Loan-Loss Rates and Outstanding Loan Portfolio

In a recent blog entry entitled ‘Is 95% a good collection rate?’ [1] CGAP Senior Advisor Mr Richard Rosenberg discusses the misconceptions about collection rates in the microfinance world. His blog has attracted significant comment and queries, some of which are referred to below. According to Mr Rosenberg, MFIs that report collection rates of over 90 percent or 95 percent in some cases are typically viewed positively by the press and by other market participants. He cautions that the situation may not be as promising or straightforward as it sounds and that ‘for most MFIs a collection rate of 95 percent would be unsustainable’. One should not equate a 95 percent collection rate with ‘losing just 5 percent of [our] portfolio a year to loan default’ as the reality is often more complicated. In an extreme scenario, he adds that ‘if an MFI makes 3-month loans repayable weekly, and collects 95 cents of every dollar it lends, it will lose almost 40 percent of its loan portfolio in a year’. This is a scenario he explains in some detail in his blog and is summarised below.

Referring to the ‘loan-loss rate’ (which represents the percentage of loan assets that are lost in bad loans each year), Mr Rosenberg states that the maximum sustainable loan loss rate is about 5 percent of the loan portfolio a year for most microcredit operations. When the rate exceeds that, things usually spiral out of control rapidly unless the rate is brought down quickly. Above that level, borrowers will start to notice that other borrowers aren’t paying and they may feel foolish if they continue to repay. Their incentive to repay stems from the MFIs implicit promise of another loan and this incentive weakens when borrowers start to fear that the ‘MFI may not be around to make future loans’.

Mr Rosenberg continued with the following example: ‘If I have USD 100,000 in cash, how many loans of USD 100 can I have outstanding? If I make all the loans on the same day, the answer is obvious-1,000 loans’. But because most MFIs spread the disbursement dates of the loans randomly over several months, the asset of USD 100,000 can support almost 2,000 loans of USD 100 at a time, these loans can be financed with repayments received on prior loans. He clarifies that ‘at any point in time, some of the borrowers owe me USD 100, some of them owe me only their final payment, and the rest of them owe me something in between’. So based on this example, the original disbursed amount of these USD 100 loans totals about USD 200,000, but the loan portfolio (which is the total owed by the borrowers) is only about USD 100,000. In general, the value of a microloan portfolio tends to be roughly half of the originally disbursed amount of the active loans. He goes on to state that a 95 percent collection rate will mean that 5 percent of USD 200,000 (or USD 10,000) is lost in bad loans. If this loan cycle is repeated every quarter however, ‘I lose USD 10,000 four times a year, for a total loss of about USD 40,000, which is about 40 percent of my USD 100,000 in loan assets’.

In response to the blog, a commentator known as V Rengarajan noted that statistics on collection rates are not the be-all and end-all and that ‘all that glitters is not gold’. Mr Rengarajan talks about certain unethical practices that some institutions adopt on the supply side to maintain these impressive statistics. These include forcing borrowers to accept uniform loan sizes irrespective of individual borrower needs, imposing irrational repayment schedules that do not match income generation activities of borrowers (particularly where dairy and crop cycles are concerned) and other sometimes drastic measures to improve collection. Other commentators seemed to question how a ‘5 percent delinquency can be equated to a capital erosion of 40 percent’.

Market participants need to be aware of the incentives that some MFIs may have to provide misleading statistics and figures, particularly as a result of pressure from donors and investors. As pointed out in a previous Microcapital.Org publication [2], ‘MFIs that truthfully reported delinquency and default rates of 1-5 percent were pushed to the bottom of the grant application pile’. Quite often, some MFIs simply write off bad loans or simply leave bad loans on their books for extended periods instead of categorizing them as delinquent loans in order to secure continued funding. In a similar vein, financial ratios and numeric indicators of profitability may not be a true reflection of the strength of an MFI, as pointed out in a previous Microcapital.Org story [3].

It is important to recognise the pressures on MFIs to report data in a certain light and the scope for misinformation in the microfinance sector. Terms such as ‘delinquency’, ‘collection rate’ or ‘repayment rate’ are not always approached with the same methodology and can often be used to mask the real financial position of an MFI.

By Chinq Yee Chong, Research Assistant

Bibliography

[1] CGAP Blog entitled ‘Is 95% a good collection rate?’: http://microfinance.cgap.org/2009/09/17/is-95-a-good-collection-rate/

[2] MICROCAPITAL.ORG publication on misinformation: https://www.microcapital.org/cfo-magazine-on-microfinance/

[3] MICROCAPITAL.ORG STORY: CGAP Microfinance Blogger Observes That Ratios May Not Accurately Reflect Real Strength Of Microfinance Institutions