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MEASURING DELINQUENCY – KEY BEST PRACTICES INDICATORS

MEASURING DELINQUENCY – KEY BEST PRACTICES INDICATORS. In the normal case, i.e., when the loan term is not over, arrears rate understates the (delinquency/default) risk in the portfolio by as much as 81.85%. 

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MEASURING DELINQUENCY – KEY BEST PRACTICES INDICATORS

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  1. MEASURING DELINQUENCY – KEY BEST PRACTICES INDICATORS • In the normal case, i.e., when the loan term is not over, arrears rate understates the (delinquency/default) risk in the portfolio by as much as 81.85%.  • In the special case scenario - i.e., when the loan terms are over, both PAR and Arrears Rate provide the same measure of (delinquency/default) risk in the portfolio.

  2. MEASURING DELINQUENCY – KEY BEST PRACTICES INDICATORS • This is because all of the arrears amount and outstanding principal balance are equal in this case (but they need not be always).  • Therefore, as highlighted by the normal case, MFIs are better off in using the Portfolio at Risk (PAR) rather than Arrears Rate as a true measure of delinquency.

  3. MEASURING DELINQUENCY – KEY BEST PRACTICES INDICATORS • This is because when a borrower is in arrears, the default risk (of not paying back to the MFI) not only arises from the arrears amount but also from the other amounts due (in the future) from the borrower.   • Therefore, PAR is better as it takes the entire stream of payments due from the borrower unlike the arrears rate which just takes into account overdue amount

  4. Adjusting the Portfolio at Risk Measure • As noted earlier, PAR has a serious limitation in that it is affected by sudden and large increases in outstanding portfolio and/or decreases in the unpaid principal balance which can be caused in any of the following ways: 

  5. CASES, EXERCISES AND PROBLEMS • Disbursement of loans • Rescheduling of past due loans   • Re-financing of past due loans   • Loan write-offs

  6. CASES, EXERCISES AND PROBLEMS • Disbursement of loans (increases outstanding portfolio but will not have an impact on the unpaid principal balance of past due loans, especially, if the repayment schedule has not begun)

  7. CASES, EXERCISES AND PROBLEMS • Rescheduling of past due loans (reduces the unpaid principal balance of past due loans by making them current; there is no impact on outstanding portfolio)

  8. CASES, EXERCISES AND PROBLEMS • Re-financing of past due loans (reduces the unpaid principal balance of past due loans by making them current and also increases the outstanding portfolio)

  9. CASES, EXERCISES AND PROBLEMS • Loan write-offs (reduces the unpaid principal balance of past due loans and also reduces the outstanding portfolio) 

  10. CASES, EXERCISES AND PROBLEMS KEY POINTS - RECAP

  11. CASES, EXERCISES AND PROBLEMS • BOTH OF THE ABOVE HAPPEN, THEN RATIO DECREASES SEVERAL FOLD AND • RISK APPEARS VERY MUCH LOWER THAN IS THE CASE • Thus, one has to look at alternative ways of measuring PAR,

  12. CASES, EXERCISES AND PROBLEMS • Adjust PAR for  • re-scheduling • re-financing • write-offs and • recent loan disbursements

  13. CASES, EXERCISES AND PROBLEMS This is given in box below EXAMPLE

  14. CASES, EXERCISES AND PROBLEMS • Likewise, one can adjust the PAR for re-scheduling and re-financing EXAMPLE

  15. CASES, EXERCISES AND PROBLEMS • Similarly, one can adjust the PAR for new loan disbursements for which repayment is yet to begin EXAMPLE

  16. CASES, EXERCISES AND PROBLEMS • Finally, one can also adjust for write-offs, especially, if they have been huge. EXAMPLE

  17. CASES, EXERCISES AND PROBLEMS Loan Re-Scheduling And Re-Financing • MFI Management should have a clear policy on re-scheduling and re-financing, as they have the potential to decapitalize the RLF portfolio at all levels. • They could also result in the ‘multiplier effect’ whereby, after re-scheduling and re-financing of some (clients’) loans, other clients also feel that they could get their loans re-scheduled/re-financed.

  18. CASES, EXERCISES AND PROBLEMS Therefore, unless, the situation mandates, rescheduling and refinancing are better avoided as • If they are used to reduce delinquency, they can spell disaster for the portfolio  • they make a risky portfolio appear less risky • can result in causing clients to develop a mind set that in the event of not making loan repayments, their loans will also be automatically rescheduled/re-financed

  19. CASES, EXERCISES AND PROBLEMS • Only in cases where natural factors such as earthquakes, fires, cyclones, floods, drought wreak havoc on economies and the activities of micro-entrepreneurs, can rescheduling and/or re-financing be thought of as alternatives.  

  20. CASES, EXERCISES AND PROBLEMS • The key point to note here is that apart from camouflaging the level of risk in a portfolio, such actions also reduce the loan loss provisions and reserves.   • This particularly, is not good as the level of risk still remains the same.

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