Performance indicators in microfinance. P.V. Viswanath. Learning Goals. What are the different measures of an MFIs performance? How can these financial ratios be used to evaluate a microfinance institution?
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These ratios measure the quality of the MFIs loan portfolio. MFI portfolios are generally of better quality than those of commercial lenders.
Efficiency and Productivity
These ratios measure the efficiency with which the MFI conducts its operations. MFI rates of efficiency are much lower than that of commercial banks because their operations are highly labor-intensive.
These ratios ensure that there is enough liquidity to meet an MFI’s obligations to disburse loans to its borrowers and to repay loans to its creditors.
These ratios summarize the overall performance of the MFI.
A loan provision records the possibility that an asset in the balance sheet is not 100% recoverable. Provisions expense this anticipated loss of value in the portfolio gradually over the appropriate periods in which that asset generates income, instead of waiting until the actual loss of the asset is realized. Provisions are only accounting estimates and entries, and they do not involve a movement of cash, like saving for a rainy day.
Loan loss provisions charged to a period are expensed in the income and expense statement. The corresponding credit accumulates over time in the balance sheet as reserves shown as a negative asset. The accounting transaction is: Debit Loan loss provision; Credit Loan loss reserve
Ratio = Loan Loss Reserves/ Outstanding Balance on Arrears over 30 days plus Refinanced Loans
This shows what percent of the portfolio at risk is covered by actual loan loss reserves.
Refinanced loans are added to the denominator because a non-performing loan can be converted into a performing loan by the simple device of allowing the borrower to extend the payment period or by refinancing it.
Ratio = Value of Loans Written Off/ Period Average Gross Portfolio
This ratio represents the loans that the institution has removed from its books because of a substantial doubt that they will be recovered.
Loan losses or write-offs occur when it is determined that loans are unrecoverable. Because loan loss reserves already provided for possible losses, loan losses are written off against loan loss reserves and are also removed from the outstanding portfolio. The accounting transaction is: Debit Loan loss reserve; Credit Outstanding loans
Write-offs do not affect the net portfolio outstanding unless an increase in the loan reserve is made. When write-offs are recovered, they are booked in the income and expense statement as miscellaneous income.
Ratio = Operating Expenses/Period Average Number of Borrowers
This measures the cost of maintaining an active borrower. A borrower is an individually identifiable person who has at least one current outstanding loan. All borrowers in a group loan are counted separately.
Since the size of the portfolio is not included in the denominator as in the Operating Expense Ratio calculation, MFIs with larger loans do not automatically appear more efficient.
Pawn loans and consumer loans are excluded from the denominator, since they require far less screening and analysis efforts. (Why?)
Ratio = Number of Borrowers (excluding Consumer and Pawn Loans)/ Total Staff
Since MFIs are very labor intensive, this is a very important measure of efficiency.
Low staff productivity often is due to excessive paperwork.
A variant of this ratio is the loan officer productivity ratio, where the denominator includes all personnel whose main activity is the direct management of a portion of the loan portfolio; it does not include administrative staff or analysts who process loans without direct client contact.
Ratio = Interest and Fee Expenses/ Period Average Gross Portfolio
This ratio measures the total interest expense incurred by the institution to fund its loan portfolio. The difference between the portfolio yield and the funding expense ratio is a measure of the net interest margin.
The funding expense ratio plus the provision expense ratio plus the operating expense ratio determines the minimum lending rate an MFI must charge to cover tis costs.
If the MFI uses non-debt sources of finance, obviously this ratio underestimates the total cost of funds.
Ratio = Interest and Fee Expenses/ Period Average Funding Liabilities
The denominator contains all funding liabilities of the MFI, including deposits, commercial funds, subsidized funds and quasi-capital. It does not include accounts payable, since these are short-term obligations not directly related to the lending operations of the MFI; neither are mortgage loans obtained to finance the MFIs buildings, for the same reason.
This ratio measures the average cost of the company’s borrowed funds and shows whether it has access to low cost funding sources, such as savings.
Operating Expenses are adjusted for subsidized cost-of-funds and for in-kind donations.
Cost-of-funds are computed at market rates and the difference is added back to the financial expense.
The market rate used should be the prime rate, adjusted for the riskiness of microloans.
In-kind donations add in the cost, or fair market value, of goods and services that the MFI does not pay for but that are important to the operation of its business. This could include technical advice, training, rent, use of transport and so on.
If FSS is below 100, the institution is considered subsidy-dependent.