MICROCAPITAL.ORG STORY: CGAP Microfinance Blog Comments On Case Studies On The Liquidation Of Microfinance Institutions And Highlights Challenges Associated With Retaining Borrower Repayment Incentives In The Midst Of A Deteriorating Loan Portfolio

In a blog on the CGAP Microfinance Blog portal entitled ‘When MFIs fail, is their loan portfolio worth anything?’ [1], Senior Advisor to Research and Market Intelligence Team at CGAP, Mr Richard Rosenberg refers to Mr Daniel Rozas’s publication entitled ‘Throwing in the Towel: Lessons from MFI Liquidations’ [2]and makes some observations about the steps an MFI should take to maximise collections on a deteriorating loan portfolio. Mr Rosenberg notes that Mr Rozas’ article offers a ‘useful, timely, concise, and readable study of a half-dozen MFI failures, focusing on efforts by creditors and others to collect the loan portfolio of the defunct institutions’ but cautions that some of Mr Rozas’ recommendations may be difficult to implement in practice.

The topic is an important one, particularly in the current financial turmoil. Institutions that lend to MFIs often use that MFI’s loan portfolio as collateral for their loan. Similarly, structured finance investors purchase bonds that are ‘backed’ or collateralised by MFI loan portfolios in securitization deals. In view of the financial crisis and dampened investor sentiment, securitization activity has been significantly reduced in the past 18 months or so. In these transactions, there is often an implicit assumption that ‘if the MFI gets into trouble, someone else can collect its outstanding microloans’. In his article, Mr Rozas offers five case studies of distressed MFIs. The five cases appendixed in the report relate to the following organizations: SOMED in Uganda, WEEC in Kenya, Bank Dagang Bali in Indonesia, FOCCAS in Uganda and ICICI Bank in India [3]. It should be noted that ICICI Bank was not cited to illustrate an MFI failure followed by a liquidation (as the preceding case studies were) but it was used to show what might happen when investors are faced with collecting on a loan portfolio, without the cooperation or servicing infrastructure of the originating MFI.

In his blog, Mr Rosenberg describes microfinance as a ‘high-touch business’ where successful collection depends strongly on the borrowers’ relationships with individual loan officers and most importantly on borrowers’ expectation that their faithful repayment of their current loan will be rewarded by continued access to loans in the future. He adds that ‘when an MFI fails, its collection system is no longer functional, and clients’ principal incentive to repay disappears’. The assumption that there will be another MFI willing to ‘pick up the portfolio’ is possible, in theory, although Mr Rosenberg reminds us that ‘it can be hard to make such an arrangement work in practice, as painfully illustrated by the example of FOCCAS in Uganda’. In reality it is often ill-founded to assume that a ready buyer can be found for a failing MFI’s loan portfolio.

Although Mr Rozas’ paper contains useful suggestions on the pre- and post-default steps that an MFI can take to ‘maximize the chance of collecting a failed MFI’s loan portfolio’, Mr Rosenberg’s view is that lenders should not be overly optimistic about the value of such a loan portfolio ‘even if all those recommendations are implemented’.

A commentator to the blog known as Ms Deborah Burand was quoted as stating that not many microfinance practitioners would be willing to advance Mr Rozas’ recommendations. In response to one of Mr Rozas’ recommendations that ‘it is probably best to repay local creditors first’ in a post-default scenario, Ms Durand observed that from a policy perspective it would be unhealthy for ‘the microfinance sector to encourage weakened MFIs to cherry pick among creditors and pay their local creditors before foreign creditors’. Indeed such practices may fall foul of insolvency laws in some jurisdictions.

Other recommendations by Mr Rozas include the suggestion that the MFI’s management should, in almost all post-default scenarios, be replaced as soon as possible but that staff in charge of collections should be incentivized (through collection related bonuses or other measures) to promote early recoveries.

Mr Rozas’ paper has been set out in the Bibliography section below along with other Microcapital.Org stories on related issues [4], [5],[6].

By Chinq Yee Chong, Research Assistant

Bibliography

[1] CGAP Microfinance Blog entitled ‘When MFIs fail, is their loan portfolio worth anything?’: http://microfinance.cgap.org/2009/10/02/when-mfis-fail-is-their-loan-portfolio-worth-anything/

[2] ‘Throwing in the Towel: Lessons from MFI Liquidations’ 20 Sep 2009, Rozas, D.: http://www.microfinancegateway.org/p/site/m/template.rc/1.9.38716/

[3] ICICI Bank India: www.icicibank.com/

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

[5] MICROCAPITAL.ORG STORY: Citi Microfinance Executive, Robert Annibale, Says Financial Crisis Will Spur Microfinance to Move Toward a Banking Model

[6] MICROCAPITAL.ORG STORY: Article in US Banker Magazine Refers To Microfinance Banana Skins Report 2009 And Analyses The Impact Of Global Financial Crisis On Microfinance Sector Based On Observations By Citi Microfinance, CGAP And ShoreBank International Ltd.