CREDIT RISK MANAGEMENT FOR MICROFINANCE INSTITUTIONS
Credit risk management is a key part of the overall risk management for microfinance institutions. That risk is often managed by offering group lending products where members of the group keep each other accountable for payment. Should one member not be able to make his payment, the others must pay a bigger share. Peer pressure often prevents members who would be tempted to miss a payment from doing so.
Borrower screening is also an important part of credit risk management. Knowing that most of the potential borrowers do not have a credit history, developing tools that will allow institutions to get an idea of the risk that borrowers won’t repay or will be late in their payments can be challenging.
Most institutions make sure that borrowers have sufficient disposable income to make the monthly payments by looking at their current monthly income and expenses. However, other factors might also give an idea of the willingness and ability to pay of the borrower. Looking at historical data to see what factors have influenced repayment rates in the past can be a useful exercise. A credit scoresheet can then be generated by choosing the factors with the highest correlation with repayment rates.
Such factors may include the following:
- Age: Are young borrowers more likely to default or be late than older borrowers?
- Gender: Are there differences between male and female borrowers?
- Assets: Are borrowers with more material goods less likely to experience repayment issues than borrowers with fewer goods?
- Liabilities: Do borrowers with loans at other institutions more likely to experience repayment issues?
- Disposable income: Are borrowers with more disposable income less likely to experience repayment issues than borrowers with less disposable income?
- Age of Business: Are borrowers with new businesses more likely to experience repayment issues than borrowers with more mature businesses?
- Length of Current Residency: Are borrowers well established in their neighborhood less likely to experience repayment issues than newcomers?
- Marital Status: Are single borrowers more likely to experience repayment issues than married borrowers?
- Repayment experience: For borrowers who have already taken a loan with the institution, is their past behavior in terms of repayment a good indicator of future behavior?
- Economic activity: Are borrowers in certain economic sectors more likely to experience repayment issues than borrowers in other economic sectors?
- Geography: Are borrowers in certain geographical areas more likely to experience repayment issues than borrowers in other areas?
Using a credit scoresheet based on multiple factors is a great way to screen borrowers for potential repayment issues. Borrowers with a likelihood of repayment issues too high for the risk appetite of the institution can then be screened out. Risk management must then be balanced with social considerations to ensure that the institution maintains its focus of serving clients with very few resources.