managing risk.pdf
managing risk.pdf
managing risk.pdf
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Managing Risk and Creating Value with Microfinance43Using data from their own client histories, however, MFIs can improve their assessment of client <strong>risk</strong> byanalyzing how characteristics like gender, length of time at current address, and length of time at currentemployment correlate with loan performance. From this analysis, the loan officer can determine if a prospectiveborrower is more or less likely to repay the loan on the basis of the performance of clients with similar profiles.For repeat borrowers, the performance of their past loans also enters in the calculation (Schreiner 2003).Using segmented <strong>risk</strong> evaluation along with traditional <strong>risk</strong> assessment methods, like workplace visits andinterviews with references, MFIs can determine which borrowers pose the highest <strong>risk</strong> of default. Usually,the highest-<strong>risk</strong> clients are rejected, but other clients may be grouped into <strong>risk</strong> categories of average to high,average to low, and low, for example. The <strong>risk</strong> component of the interest rate charged on their loans would thenbe priced according to the historical loss rates associated with borrowers in their same category.Finally, the profit component of an interest rate should be determined on the basis of the MFI’s growth targets.Without additional equity, the institution is constrained in the amount of money it can borrow and lend to itsown clients. To support long-term growth, MFIs should target a capitalization rate between 5 and 15 percentof the average outstanding loan portfolio. Internally generated capital is arguably the best source of new equitybecause it enables the MFI to expand services to more borrowers or loan more money to existing clients. TheMFIs represented in figure 3.1 were earning between 3 and 7 percent returns on their portfolios.Are Microfinance Interest Rates Too High?Some observers seem to think that MFIs are taking advantage of their clients with abusively high interestrates. Worldwide, the MFIs for which data are available charge their borrowers an average interest rate of 35percent (Kneiding and Rosenberg 2008). Is this too much to charge poor people for borrowing money? Thereare several ways to approach this question. First, from the borrowers’ perspectives, the costs and other terms of aloan from an MFI must generally be better than the terms offered by alternative sources. Otherwise, borrowerswould not take the loan from an MFI. Indeed, thousands of MFIs extend credit to the poor around the globe.This finding suggests that the price is not a determining factor for a large pool of low-income clients. 7 Inaddition, while 35 percent may be high compared to rates in mainstream banking, the costs of making manysmall loans are higher than the costs of making larger loans—box 3.1 explains why. Moreover, most MFIs arenot profiting greatly from their customers. Most of those MFIs that report their financial data declare a modestmedian rate of return on capital of only 1.1 percent.7. See the interview with Richard Rosenberg (CGAP 2008). See also, for example, Rosenberg (2007) and Epstein and Smith (2007).The data suggest that MFI rates are less than informal moneylending charges (CGAP 2008).