SRSP from its experience in microfinance has learnt that the credit risk can be managed in three ways: First is collateral (social is more effective than financial), information and credit policies. Collateral demonstrates borrowers’ willingness to repay and serves as a secondary repayment source if they are unable to repay. Information about the characteristics of loan applicants and the behavior of the borrowers helps the institution avoid selecting risky clients and influences the ongoing relationship between the lender and borrowers. Proven Credit policies and procedures provide the framework for the entire credit management process. Written credit policies set objective standards and parameters to guide loan officers as well as provide management and the auditors with the basis for performance evaluation.
In light of the above, credit risk under its microfinance program is being managed by SRSP in the following manner:
- Steps that we take as lender before issuing the loan (Pre-Loan) and
- Steps that are taken to minimize credit risk after issuing the loan (Post-Loan).
Before issuing the loan, staff screens applicants to see if they are credit worthy. This involves household assessment to judge that they have the capacity to repay, as well as a character check to ascertain the applicant’s willingness to repay.
After issuing the loan, the management balances incentives to repay (carrot) and consequences of default (sticks) to maintain the quality of our loan portfolio. We do not relay on one or two tactics to encourage repayment and manage delinquency but rather follow a comprehensive strategy that is involved an array of measures. Each particular measure may not be sufficient to achieve the objective however we strongly believe that as a complete package they are proven very effective.
The steps that are taken before issuing the loan we consider very critical in managing credit-risk. The main objectives of the pre-loan activities are to ensure that applicants meet the eligibility requirements, to determine their capacity and willingness to repay, and to ensure that they understand the terms and conditions of the loan. The first among the steps come the Client-Screening. We feel that Client-Screening is not an exact science, but when the process works properly it makes the other facets of managing credit risk more effective. The investment of time that we make in screening the clients give us the confidence to reap the rewards in the form of having a healthy portfolio.
The following steps are being followed to make the screening process more effective:
- Unlike the past while operating in rural areas, the micro-credit services are made available in close proximity to the branches to keep the mobility cost lower. Moreover, the services have also been made demand driven. Disbursement targets are set deliberately below the potential demand for small loans in the area. It was to ensure that loan officers do not feel pressured to skip in the screening process.
- It is made sure that the front line staff members adhere to the established criteria for clients’ selection. The head office maintains a careful oversight of field staff behavior through frequent procedural audit. Branch Managers- heading the branch- lose points towards their final score (which decides their rewards at period end) for any non-compliance even against a single case.
- Head Office is cognizant of the fact that in the absence of well-trained and highly motivated staff even the perfect credit technology does not often work well. Thus besides designing effective screening tools, staff is provided with the skills and the incentives to properly implement them. The system is focused on portfolio-quality with outstanding growth.
- The credit risk by SRSP is further managed in the following manner:
- Firstly through an in-depth business and household assessment. During the process, the loan officers collect data about household assets and cash flow. They consider it important because other household income (e.g. spouse salary or a pension etc.) serves as the main form of secondary repayments. Having a variety of other source of income puts the SRSP at a comfort level.
The collection of data on the business and household is usually not as important in approving the loan application as the credit officer’s subjective assessment of the client’s trustworthiness. It is believed
- that this is a skill that the credit officers at SRSP develop over time. During the assessment process, skilled loan officers at SRSP scrutinize the business, the household, customers, family members and most importantly the applicant’s verbal statements for inconsistencies and hints of dishonesty.
- At SRSP most loan rejections are based on character and not on business assessment. Rejection occurs if the credit officer learns that the applicant is not respected in the community or has misrepresented him/herself in the application. SRSP identifies the neighbor’s assessment of the applicant’s character as the most important means of predicting a new applicant’s future repayment behavior, which is considered most important than the business assessment.
- To ensure that a perspective client is trust worthy and that she will repay the loan we take non-traditional collateral in the form of asking two members from the group to co-sign the loan as guarantor. Guarantors’ willingness to cosign the loan, we have experienced, sufficiently reduces the credit risk.
It has been experienced that the process plays a pivotal role in educating the perspective client about the lender motives and mechanism in addition to forging a positive working relationship between the client and the loan officer.
When applications are received for approval, the concerned Branch Managers interview the client in person either by visiting her at her house or by calling her to the branch to verify the application. The measure reduces risk of ghost loans and enhances staff training. It also ensures that Branch Managers visit all clients, which justify their loan approval authority with due responsibility.
It is a known fact in lending business that loan transaction changes the nature of the client-lender relationship. Before loan disbursal, the applicants may do or say whatever is needed to be extended a loan, however as the disbursement takes place the roles are reversed. The management thus does not just rely on client selection to manage credit risk. Instead, we have developed an Incentive System to encourage clients to repay their loans and staff to maintain the portfolio quality at the desired level.
Clients who are regular in repaying their loan installments can access loans with bigger ceiling against lower cost of borrowing and for longer period. Star clients (no late-payments during the loan period) gets even an access to parallel loan based on her repayment capacity. Delinquent clients however charged with a penalty to make them disciplined in their repayments. Clients with good repayment behavior are extended repeat loan more swiftly.
All clients in good standing for one year can access parallel loans. To determine eligibility for preferred services, the management uses a rating system to categorize client repayment performance as shown below. Qualitative and quantitative information are considered important while allowing access of a repeated client to preferred service. In addition to client credit history in light of the below rating system, her access to preferred services is also subject to the loan officer’s judgment of her repayment capacity against increased loan ceiling.
The formality of this rating system creates a transparent relationship between repayment and preferred services. Access to these services we have seen is a significant incentive to encourage timely repayments of installments by the clients who value their relationship with the organization.
During the first follow-up with delinquent clients, our loan officers are respectful. Since the bond between credit officers and client is one of mutual respect, when visiting delinquent clients we want to maintain a good relationship with our clients. This means that we refrain ourselves from embarrassing our clients. Credit officers are instructed to make a follow-up with late payers the day immediately following their due date, or within a week at the most. This face to face contact we consider an important psychological reinforcement, and visits provide opportunities to discuss problems and solicit referrals.
We have witnessed in the past that the effects of one delinquent client can have a profound influence on the loan repayment behavior of others. Since micro-loans are typically promoted by word-of-mouth, information about the institution’s response to late payers, whether strict or lenient, can spread rapidly through this same channel of communication.
While disbursing loan to a rural client, it is mandatory that the perspective borrower has the backing of her rural group (WCO) in the form of a written resolution favoring her facility. The resolution has the signature of the most of the members with a promise that peer pressure will be exercised in case the client goes in default. Additionally, a blank cheque against the group saving account is also taken as a guarantee, which SRSP can present to the concerned bank in case the group as a whole does not keep their promise of executing group pressure against the delinquencies.
Moreover, in rural programme, since clients represent a community organization therefore delinquency reflects on a community relation with SRSP. Since SRSP offers a variety of services to community organizations in rural areas, thus MCOs (men community organization) and WCOs (women community organization) with an outstanding credit history with SRSP only stand eligible for grant based facilities such as Community Physical Infrastructure Schemes (CPIs).
Clients who ‘can’t pay’ or ‘won’t pay’ are charged with a delinquency fee if they fail to repay their loan installments before month end. The monthly fee is 1 percent of the loan amount. We consider charging delinquency fee important because without a penalty for late payments, good borrowers are effectively subsidizing delinquent clients.
Both in rural and urban operations, perspective clients do provide personal guarantee of two individuals. The sign a ‘promissory note’ against which SRSP can take a legal action if it is forced to.
Besides encouraging clients to repay through use of incentives, SRSP also motivate staff to enforce delinquency management polices through performance incentives. Regular reporting on performance indicators is ensured which highlights employee awareness.
As per staff incentive system, microfinance staff is provided with a base salary that is supplemented by performance-bonuses. Performance indicators are carefully chosen and thus bonuses are also tied directly to portfolio quality. The aim is to send the message that portfolio quality shall not be sacrificed to achieve growth.
The said incentive system has been proven very effective in encouraging loan officers to pursue late payers aggressively, to be selective in approving new loans, and to be careful about issuing repeat loans to clients with less than perfect credit histories. |
