Is 95% a Good Collection Rate?

I still see lots of discussions of microfinance in the press and elsewhere reporting enthusiastically that MFIs get extremely good repayment, as evidenced by collection rates over 90 or even (holy cow!!) 95 percent. But in fact, for most MFIs a collection rate of 95% would be unsustainable: at that level, delinquency will have already spun of control and the institution won’t be around much longer unless drastic action is taken to improve collection quickly.

When we think of a 95 percent repayment rate, most of us tend to assume that this is equivalent to losing just 5 percent of our portfolio a year to loan default. This turns out to be very far off the mark. If an MFI makes 3-month loans repayable weekly, and collects 95 cents of every dollar it lends, it will lose almost 40 percent of its loan portfolio in a year. (Yikes! Can this possibly be right? How?)

Let’s start with the concept of a loan loss rate–the percent of my loan assets that I lose in bad loans each year. As it happens, the maximum sustainable loan loss rate turns out to be about 5 percent of the loan portfolio a year in most microcredit operations. When loan losses go higher than that, they usually spin rapidly out of control unless they are brought down very quickly. Above that level, borrowers seem to notice that lots of other borrowers aren’t paying. They may feel like suckers if they continue to pay. More importantly, their main incentive to repay stems from the MFI’s implicit promise to give them another loan when they want it, and this incentive weakens quickly when borrowers see widespread default and start to worry that the MFI may not around to make future loans. (The borrowers are poor but they’re not dumb.)

Next, we need to look at the relationship between the amount an MFI disburses in loans and the size of its loan portfolio asset. (The discussion gets slightly more complicated here. If you have any trouble following it, you can find a step-by-step explanation in CGAP’s Occasional Paper No. 3 on delinquency measurement.)

If I have $100,000 in cash, how many loans of $100 can I have outstanding? If I make all the loans on the same day, the answer is obvious–1,000 loans. But if, like most MFIs, I spread the disbursement dates of the loans randomly over the months, my $100,000 asset can support almost 2,000 loans at a time, because I can finance some of those loans with repayments I’ve already received on prior loans. At any point in time, some of the borrowers owe me $100, some of them owe me only their final payment, and the rest of them owe me something in between: the average outstanding balance of the loans will be a bit over $50. So if I have $100,000 I can finance almost 2,000 of these loans. The original disbursed amount of these $100 loans totals about $200,000, but the loan portfolio (the total the borrowers now owe me) is only about $100,000. In general, the value of a microloan portfolio tends to be roughly half of the originally disbursed amount of the active loans.

Most of my MFI’s money is in my loan portfolio. Let’s see what happens if I collect 95% of the amount I lend out (i.e., disburse to borrowers). I’ve lent out $200,000 on my present portfolio of loans. If 95% of this eventually gets repaid, then I’ve lost 5% of $200,000, or $10,000. And since I’m repeating this same loan cycle every quarter, I lose $10,000 four times a year, for a total loss of about $40,000, which is about 40% of my $100,000 in loan assets. For 3-month loans, I can keep my annual loan losses below 5% only if I have a collection rate of about 99.3%. Really.

This gives us a useful perspective on how impressively high repayment is at good MFIs. The annual loss rate for MFIs reporting to the MIX Market averages at or below 2.5%. If we assume that the average loan term is six months repayable biweekly, this means that borrowers are repaying over 98.6 cents of every dollar that MFIs lend them. Not bad.


10 September 2012 Submitted by Laura B (not verified)

Thanks Rich for a good ‘back to basics’ reminder. I have a question I’m hoping someone can help me with. I read often in different contexts that the main motivator for repayment of a microloan is anticipation of the follow on loan. Absent this, motivation dwindles. Meanwhile, there seems to be evidence in many countries of borrowers using loans from other institutions to pay existing loans, as well as overindebtedness due to easy access to credit in competitive markets. So, given increasingly ample ability to find alternative financing – that is, the borrower’s MFI is not the only game in town and lots of viable options exist – how true will this assumption be down the road? What will motivate repayment? Harsher collections? Taking collateral a borrower can’t afford to lose? Will average repayment rates naturally decline? Would love to hear any thoughts on this.

10 September 2012 Submitted by Dr V.Rengarajan (not verified)

Good collection rate!!!… “All that glitter is not gold.” A good collection rate (for the supplier) depends on good repayment (by the poor client) which again ultimately hinges on income generation and repaying capacity at household level. Therefore it is more useful to perceive the dynamics of the factors which influence the collection from demand side perspectives ( a rare posting in this blog) as it also more relevant to the mission of Micro finance towards poverty reduction.

In most cases the repayment is not made from the income generation. that is where the shoe pinches. Empirical studies reveals that unethical practices are followed by the supply side institution (so called MFIs)for just keeping the ‘cow’ to appear to be holy. They include a) uniform size loan irrespective of individual poor clients’ need( mechanically dividing the available funds equally to the given number of poor – no botheration of purpose and end use of the micro credit) ‘One size fits for all’ is quite illogical in the context of poverty reduction, b) irrational repayment schedule (mechanically fixing equal amount of installment for every monthly/weekly, without linking to the repaying capacity or the potential for income generation of the purpose or scheme for which micro loan issued,) c) No initial repayment holiday for incubation period of the scheme or in the middle period of scheme (as in the case of dairy scheme, during non lactation period ) Mainstream banking workout scale of finance (size) and repayment schedules (some holiday period for some desrving schemes) for each one of the credit products to match the potential and the need of the poor client under priority sector lending programme d) repeat loan for just closing the earlier one, e) Non risk coverage of the life and livelihood asset borrowed out of micro credit under micro insurance scheme (another vital constituent of Micro finance )for ensuring protected income generation in the case of loss- this factor also influences the level of persistent repayment and good collection trend .f) ‘Drastic action for improving the collection’ and incentives for good collection and peer pressure in the case of SHG system where evidently the poorest or the defaulters are dropped out or pushed out ( MF for financial inclusion or financial exclusion ?) I have also made similar observations in my empirical studies in south India.
This unethical collection drive process is very unfair to happen in Micro finance platform . Two empirical reference revealing the real happening at the grass root level on the subject -one in Bangladesh and another in India.

Aminur Rahman (1999), who probed micro financing to women from anthropological perspectives, are presented below . (Critical appraisal on Grameen Bank (GB)Evan Selinger– Micro finance gate ) To quote”-In some instances peer pressure has forced women borrowers to take on expensive loans from money lenders to repay the bank loan” -There have been cases of women from the most destitute or socially depressed group being excluded from the membership of groups containing better off members because of fears that their inability to repay will damage the prospects of other members) -The husbands who were excluded by GB Policy , force their wife to sign up for loans and forcibly appropriate the funds for them. In such case the author raises question how women are empowered.? The anthropologist claims that GB generates an ideology that obscures the connection between micro loan practice and the larger structure of patriarchy. -The goal is not to tell the truth but to placate authorities and ensure that they can continue to qualify funds
Marc Roesch, Cyril Fouillet, and Isabella Guerin from French Institute of Pondicherry make some reference on the subject .( In Andra pradesh- Krishna district) in their paper for the workshop on indebtedness and over indebtedness (2006). According to the paper, “
“The press also reports several cases of credit agents advising those clients who can no longer manage to pay , to apply for a new loan In time , the situation degenerates and repayment becomes impossible. Verbal and sexual harassment culminating in prostitution, lock up and confiscation of goods are the dire consequences.”. In another place, it is quoted “ The controversy in connection with the IMF’s(MFI) methods of recovery took a new dimension on Wednesday, April 5th, when as SML client hacked a credit agent to death. Arrested by police, he explained why he could no longer bear the harassment and the pressures exercised by the IMF(MFI).

In Micro finance arena, a judgment on good collection need to be based on its value addition to the welfare of the poor client at their household level or at what social cost rather than on statistically claimed with ‘glittering’ percentages (95% or 100% )at surface level or at supplier level.

10 September 2012 Submitted by N.Srinivasan (not verified)

I am missing something here. The collection rate is some thing like what proportion of loans that fell due during a given period (normally a year) were collected as reckoned at the end the period. The amount remaining uncollected does not become a loss – with a time lag it tends to get collected as well. Loan loss and collection rates differ as anything past due cannot be assumed to be lost and written off. (There is a difference between provisioning and reckoning of loss)

The uncollected amounts (forming part of the 5% in your example)also include what remains for more than one accounting period, as MFIs (and banks) write off chronic overdues after exhausting different possibilities. A study of amounts written-off out of loans disbursed in any given year might give us better insights in to loan loss rates. The accumulation of portfolios, past due loans as well provisions and write-offs over more than one accounting period make a correct reckoning difficult. We should try to segregate year-wise loans give say five/four/three years back and see what has happened to collection rates.
Low collection rates impose liquidity problems on the MFI and they need to find more funds than they disburse as they have to meet repayment obligations on time. On revenue side they might not suffer, if they eventually collect the loans; they would also have collected additional interest for the carry over period beyond due date.
N.Srinivasan – Consultant

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