One of the most important determinants of a successful micro lending operation is the successful management of default risk or, more simply, keeping loan delinquencies to an acceptable level. The need to keep a portfolio current is important for the obvious reason that an institution its loans to be repaid if it is to survive and thrive. On a higher, systemic level, maintaining low delinquencies is critical for minimizing moral hazard that can result in mass defaults across a financial system.
The private informal sector accounts for 86.1% of the working population of Ghana (2010 Population and Housing Census). The private sector has been largely recognized as an engine of growth to achieve sustainable development, wealth creation, and employment in Ghana. The government of Ghana recognizes microfinance as an important tool for poverty reduction, linking the overall policy framework for microfinance with the poverty reduction strategy for the country. (MFTransparency, December 2011). Helping to boost credit availability to the informal sector is critical since it continues to accommodate a large chunk of the country’s entrepreneurial community yet receives the least financial attention from banking and non-banking financial institutions nation-wide. There are a number of MFIs providing financial services such as savings, insurance, funds transfers and provision of credits to micro businesses and the poor in Ghana. Credit risk continues to be leading risk for these MFIs.
Delinquency tends to be more volatile in MFIs than in commercial banks. Most microloans are not secured by tangible assets that can be seized or sold easily in case of default (CGAP, 1999). Delinquency and default threaten the viability of MFIs.
As an MFI (financial NGO to be specific), SSF was formed with the purpose of providing social and financial solutions to the poor. The achievement of this purpose exposes SSF to a number of risks, credit risk being the leader. To determine its vulnerability to credit risk, there is review of the policies and procedures at every stage in the lending process to determine whether they reduce delinquencies and loan losses to an acceptable level. These policies and procedures include the loan eligibility criteria, the application review process and authorization levels, collateral or security requirements, as well as the “carrots and sticks” used to motivate staff and compel borrowers to repay. In addition to analyzing whether these policies and procedures are sound, it is also necessary to determine whether they are actually being implemented. The best policies in the world are meaningless if staff members are not properly trained to implement them or choose not to follow them. The credit risk management techniques used by SFF are examined below;
This looks at the whole credit extension process. The various stages are:
The screening process ensures that the applicants are micro borrowers. SSF caters for low-income clients, both the underemployed and the entrepreneurs with an often informal family business (eg petty traders, vegetable farmers etc). Borrowers are typically concentrated in a limited geographic area, social segment or entrepreneurial undertakings. Loans are very small, short term, and unsecured, with more frequent repayments. The applicants are made to understand that the loans are purely for businesses and not for personal purposes such as school fees, funeral expenses. They are also made to understand if a borrower defaults, the other members in the group become liable hence the importance of keeping a cohesive group and being there for each other.
Registration of Applicants:
The applicants are then registered after they pass the screening stage. The details taken include names, gender, business location, residential address, occupation type, phone number and name of spouse or next of kin. Two passport pictures and an ID are required for the registration.
Credit risk analysis:
Loan documentation is generated largely by the Loans and Operations managers through visits to the borrower’s business and home. Directions to the residences are also drawn up for verification. The occupation/trade types of applicants are verified and report sent to management for assessment. The borrower’s character and willingness to repay is also assessed during field visits. Since credit bureau data are not available for low-income clients a labour-intensive approaches to credit analysis is used.
SSF has a highly centralized process; hence credit approval by the loan committee depends heavily on the skill and integrity of loan officers and managers for accurate and timely information.
Applicants whose loans have been approved are then trained in Basic Financial Management. They are train to distinguish between working capital and profit, in basic customer service and to inculcate in them the habit of savings. Elementary book keeping is not mandatory since most of them cannot read and write. An application fee of GHS 10.00 is then collected from the applicants to cover administrative costs involved in visitation and monitoring of loans.
Disbursement of loans:
The loans are disbursed to the applicants after the training.
MANAGEMENT OF LOAN PORTFOLIO
Use of collateral: SSF borrowers lack collateral traditionally required by banks, and hence social collateral is used as leverage to induce payment rather than to recover losses. In this case, underwriting depends on a labour-intensive analysis of the household’s repayment capacity and the borrower’s character. A group is typically made of three members who are comfortable with each other (borrowers actually form the groups themselves). The details of each group member are captured in SSF’s information system. Interest on loans is between 1% -3.5% per month for a period of 4 months or 6 months. Each group has its unique ID. Client Ambassadors (CAs) are responsible for collecting the repayments on a weekly basis. Each CA has his/her own list of clients based on geographical coverage.
Progressively increasing lending: SSF customers have limited access to other financing and are dependent upon ongoing access to SSF’s credit. SSF uses incentive schemes to reward good borrowers with preferential access to future, larger loans. The cap for first cycle loans is GHS 300.00 per individual in a group of three. A group is graduated to the second cycle after a successful repayment at the first cycle. The cap is the second cycle is GHS 500.00 per individual for a period of six months.
Controlling arrears: Strict control of arrears is employed by SSF given the short-term nature of the loans, lack of collateral, and high frequency of payments (eg weekly or bi-weekly). Monitoring is primarily in the hands of loan officers as the knowledge of the client’s personal circumstances is important for effective collections.
After Disbursement Monitoring: This is conducted by loan supervisors to ensure that applicants use the funds for purposes intended.
Credit risk continues to remain the largest source of risk for both banking institutions and MFIs and the absence of proper management of such risk has resulted in significant losses or even crippling losses for a number of these institutions. The consequence of such losses not only disrupts the intermediation function of the institution affected, but also contributes to the non achievement of the social and financial objectives of MFIs.
Isaac Kwasi Akohene-Asiedu,
Sun Shade Foundation-FNGO,