Downloading - Microfinance Information Exchange
Downloading - Microfinance Information Exchange
Downloading - Microfinance Information Exchange
Create successful ePaper yourself
Turn your PDF publications into a flip-book with our unique Google optimized e-Paper software.
FEATURE ARTICLE<br />
while if methodology 3 is used, it is largely<br />
unprofitable.<br />
Funding Costs Adjustment<br />
Rationale. While some MFIs benefit from large and<br />
numerous subsidies (in kind or in cash), others<br />
borrow funds at concessional or commercial rates.<br />
An MFI’s capital structure drives its cost of funds<br />
and therefore its financial performance. Moreover,<br />
it is expected that over the long term, most MFIs<br />
should be able to operate without subsidies, relying<br />
instead on commercial sources and private<br />
investment at market rates. Offsetting the effects of<br />
subsidies and applying a commercial funding cost<br />
will thus reveal how sustainable an MFI would be in<br />
a subsidy-free commercial environment.<br />
Accounts affected. The first step offsets all<br />
subsidies that appear in the income statement. The<br />
second step applies a commercial rate to the funds<br />
that the MFI must borrow to operate. The difference<br />
between the interest expense already paid and the<br />
commercial interest rate will then be added to the<br />
MFI’s funding expense.<br />
Main differences in adjustment methodologies:<br />
1. Interest rate. Some organizations use the<br />
interest rate that banks would grant to MFIs. This<br />
rate information is difficult to obtain, however, given<br />
that it varies from one MFI to another, based on an<br />
MFI’s risk profile, negotiation skills, or even external<br />
factors (e.g., banks may not yet be ready to on-lend<br />
money to MFIs in a particular country). For<br />
benchmarking issues, one may use the 90 day<br />
deposit rate, but this rate is often much lower the<br />
rate that banks offer MFIs. One could also use<br />
more realistic data such as the lending rate (or a<br />
fixed percentage of same) reported by IMF’s<br />
International Financial Statistics, a broad,<br />
comparable source of data available for most<br />
countries. In the case of loans denominated in<br />
foreign currencies, one-year LIBOR plus a spread is<br />
often used.<br />
Microfinanza Rating, for example, adjusts funding<br />
costs according to 75 percent of the country’s<br />
average lending rate reported by the IMF. In<br />
specific cases where this interest rate is not<br />
realistic, given the characteristics of the MFI, an adhoc<br />
adjustment is used. If local commercial banks<br />
do not work with MFIs, Planet Rating uses the<br />
interbank lending rate.<br />
2. Estimating funding needs. Most often,<br />
adjustments are based on an MFI’s average<br />
borrowings. However, this methodology does not<br />
take into account the cost of equity. For MFIs with<br />
large subsidies and no need to borrow funds, the<br />
adjustment will be zero (MFI 1). Another<br />
methodology would compute the commercial cost of<br />
funds an MFI would need to borrow during the<br />
coming year without subsidies and donated equity.<br />
In this case, an adjustment for inflation will not be<br />
made because the inflation rate is much lower than<br />
the market capital rate in most of countries,<br />
meaning that the cost of funds adjustment will be<br />
much higher.<br />
If we compare the two MFIs using different<br />
methodologies (see Figure 6) but the same interest<br />
rate, we see that MFI 1 looks stronger than MFI 2<br />
using the first methodology, while the results are<br />
reversed using the second methodology.<br />
Figure 6: Impact on profitability of different adjustment methodologies for funding costs<br />
Financial Performance<br />
Unadjusted data<br />
Adjusted data using methodology Adjusted data using methodology<br />
1 (based on loan amounts) 2 (based on funding needs)<br />
MFI 1 MFI 2 MFI 1 MFI 2 MFI 1 MFI 2<br />
Net income before donations (USD) 30 10 30 4 (18) 4<br />
ROA (Return on Assets) (%) 5.0% 1.3% 5.0% 0.5% (3.0%) (0.5%)<br />
* Assume an interest rate of 12 percent.<br />
Loan Loss Provisions and Loan Write-Offs<br />
Rationale. The treatment of delinquent loans<br />
impacts an MFI’s net income through the provision<br />
expense and write-offs. Depending on the<br />
accounting methodology, the total expense may<br />
vary.<br />
Accounts affected. Adjusting for loan loss<br />
provisions and write-offs will affect the loan loss<br />
provision expense and, as a consequence, modify<br />
the loan loss reserve (allowance), as well as the<br />
outstanding loan portfolio. This adjustment will not<br />
generally be performed if an MFI is already<br />
provisioning sufficiently (i.e., there are no “negative”<br />
adjustments). An adjustment also does not suggest<br />
that the MFI should modify its provisioning policy,<br />
rather, it determines a minimum level of<br />
provisioning that should be applied.<br />
Main differences in adjustment methodologies:<br />
1. Provisioning rates. Analysts may use<br />
provisioning rates based on regulatory agency<br />
requirements or the historical loan losses of an<br />
individual MFI, or may instead use a standard that<br />
MICROBANKING BULLETIN, MARCH 2005 5