Are MFIs’ Portfolios as Strong as They Appear?
Washington D.C., United States, December, 16 2009 -
The biggest source of risk in most microfinance institutions (MFIs) is the loan portfolio. Unfortunately, the common risk assessment tools—external audits, ratings, and evaluations—usually don’t provide a reliable check for portfolio problems. Sometimes the issue is resources: auditors and raters usually don’t have the time to do thorough portfolio testing. And because they don’t do a lot of portfolio testing, they may not be aware of the most effective diagnostic techniques
CGAP has just revised and updated its “Due Diligence Guidelines for the Review of Microcredit Loan Portfolios: A Tiered Approach.” This tool offers banking supervisors, investors, donor agencies, and microfinance managers a range of techniques to check the solidity (i.e., the likely collectability) of MFI loan assets.
The guidelines provide concrete instruction on what to analyze, and on appraisal technique. But proper interpretation of the results will require an experienced MFI analyst.
The guidelines spell out a three-tiered approach for assessing MFI loan portfolio performance and management, with increasing levels of rigor. The choice of how many tiers to use will depend on how certain the client needs to be about the portfolio in question. Tier 1 is a five-day review of basic policies, procedures, and systems for managing and reporting on loan portfolio. Tier 2 is a 10-14 day assessment of whether actual operations on the ground are consistent with the MFI’s policies and procedures and with industry standards of best practice. Tier 3 is a 3–4 week exercise that includes detailed testing of transactions, and confirming portfolio quality through a sampling of loan files, accounting files, and the loan tracking management information system.
Obviously, implementing any of these tiers will add substantially to the cost already being incurred for an audit, rating, or other evaluation. But spending more for such testing seems reasonable when one considers that portfolio risk looms larger than any other in most MFIs. MFI failures almost always involve massive default by its borrowers.