Risk sharing is among the measures that were introduced by MYC4 to mitigate risk as the learning curve fast progressed. The risk share agreements are limited to default risk only. The providers commit to pay all amounts due at the time of default including accrued interest and penalties. A default situation on MYC4 is deemed to occur after 180 days of non-payment by the borrowers. The Central Bank of Kenya classifies a loan that is late for more than 180 days as doubtful, and those more than 360 days as loss or due for write-off. The defaulted loans do not accrue any interest after they default; however any accrued interest at point of default must be paid.
To ensure that providers consistently have funds to pay the loans as they default, MYC4 requires that they set aside some funds, equivalent of 20% of the loan balance. The percentage of funds set aside is ideally meant to be equivalent to the default risk of an institution. The industry standard for default risk is about 2%; thus MYC4 takes a prudent approach to this by requiring a wider safety net. Providers have several options for providing for the 20% including bank accounts controlled jointly with MYC4, bank guarantees, escrow accounts in favor of MYC4, government paper and other financial instruments that MYC4 can legally place a lien on.
The risk share fund was introduced to align practices on MYC4 with best practice in finance. The belying factor is that when microfinance institutions (MFIs) borrow funds from any lender, they are required to pay back 100% of the loan plus interest at determined periodic intervals, regardless of whether the borrowers pay or not (on MYC4 they are only required to remit repayments that they receive from borrowers). On this understanding MYC4 now requires that the MFIs provide 100% risk share (Definitely now it is time to change the name from risk share to risk guarantee: However, this is debatable as the MFIs only guarantee default risk while the investors bear all currency risk).
The risk share agreement feeds into the risk score of the providers, commonly referred to as the star rating on MYC4. The star rating is a range of 0 to 5 with 5 stars being the best performance. The percentage covered per loan (currently set as 100% for all providers) and the percentage of outstanding portfolio covered by risk share fund (currently set as 20% for most providers) are two of three factors under the “will” category of the risk rating. The other factor under will category is the ratio of repayment fees over closing fees: partners that earn the higher percentage of their fees from collections/ repayments are deemed to have more will to manage risk than those that earn more from closing/ processing fee.
The other category in the star rating is referred to as “skill” and it captures performance related parameters. This category contains some parameters that are updated on a daily basis by the system automatically. These include PAR31+, Change in PAR31+ in last 6 months, worst PAR31+ in last 12 months, default rate and sum of repayments over total disbursed. Other parameters in the category skill are updated periodically as reviews are conducted. These include spot check score (every 6 months), annual review/ due diligence, and external rating for the last 12 months.