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