Portfolio at risk (PAR) refers to loans that are late in their repayments; it is the universal measure for quality of a loan portfolio. For computation of PAR, even when only a portion of the installment is late, the entire outstanding loan balance is assumed to be at risk. This is a strict and almost punitive way of assessing an MFI’s risk performance. The assumption is that a borrower that starts breaching the installment contract could easily fail to pay the entire amount. To arrive at the PAR figure, we divide the outstanding loan balances of all loans in arrears by the total outstanding loan balances. This figure is usually expressed as a percentage. The industry best practice standard for MFIs is PAR (30 days) of below 5%.
So why do borrowers delay in repaying their installments? Here is a non-exhaustive list:
- The first and most significant is the loan assessment done by the MFIs. The saying goes; there are no bad borrowers, only bad lenders. The MFIs must strive to give the correct amount at the correct terms to economically viable businesses that are run by people of good character.
- Diversion of loan funds by borrowers to projects that do not bring immediate returns or are very risky e.g. buying land, school fees, an opportunity to make a quick buck on an untested scheme etc.
- Multiple borrowing that is not well planned. Entrepreneurs often believe that the only hindrance to their exponential growth is lack of funds. So, in a society without adequate credit information sharing, some entrepreneurs borrow funds from as many MFIs as they can.
- Unforeseen and unavoidable circumstances beyond control of both borrower and MFI e.g. natural calamity, political strife, serious illness of key person
- Character flaws in borrowers: Some borrowers will have loan repayment as low in priority to even buying luxury items; some borrowers like to test limits; some borrowers are simply conmen that had no intention of paying from the start.
Most MFIs adopt some carrot and stick approach with their borrowers towards managing delinquency. The carrots being the positive motivators such as: Rebates on total interest for loans that are repaid with a perfect record, lower interest in subsequent loans, graduation to higher loan amounts, recognition certificates. The stick being the punitive measures such as: late repayment penalties, blacklisting of borrowers, more stringent loan eligibility criteria. Client education on need for a good credit history is also critical.
Loan monitoring and follow-up is a critical element of an MFI. MFIs must thus invest in adequate MIS capable of giving an aged analysis of each loan. The MYC4 platform also serves as a supplemental MIS to our providers.
Follow-up of loans should be systematic. A wise man once said that it is not bright to use a hammer to kill a mosquito. Similarly MFIs must use adequate but varying pressure on borrowers, depending on the seriousness of each situation. You cannot put similar pressure on a borrower that is one day late as you would on one that is 30 days late. Using varying pressure on the borrowers is commonly referred to as the graduated terror method. The other element of systematic follow-up is escalation levels. The concept of escalation levels is two-fold: The first aspect on escalation levels is on verbal contact to the delinquent borrowers, which should be first done by a relatively junior ranking officer, with the next being a higher rank in case of no response. The second aspect is on formal written communication; which should range from a polite reminder to the more severe legal demand notices. The third element of systematic follow-up is that there should be an established procedure for follow-up that must be adhered to on all delinquent loans. Documentation of the follow-up efforts and the responses is very important.
The MFIs should strive to continually train/ educate their loan officers on risk mitigation. The loan officers should also be motivated through various incentives such as performance based recognition. Loan appraisals (assessment of borrower needs, character, and ability) must be thorough as they are the first defense against loan delinquency. Monitoring must be continual, with delinquent borrowers being contacted at the earliest opportunity (there should be sufficient focus on PAR 1, not just PAR 30).
The measure of last resort in the portfolio at risk management is enforcing of the MFIs right on collateral, among other legal mechanisms. The measures include repossession and auction of the collateral. Other legal options are such as: obtaining a court order against borrower for receivership, attachment of salary to pay debt, commitment to civil jail (this has been discarded in Kenya under new constitution).