Importance of Third Party Technology Players in Microfinance

One may appreciate that despite numerous challenges, the microfinance sector at the global level, over the last three decades, has experienced a sustained growth. However, the original objectives of microfinance and the business models adopted by a number of market players did not complement each other as some microfinance institutions saw this as an opportunity to maximize the return on their investment, instead of optimizing it. In support for this approach, some stakeholders may seek refuge in higher risks associated with microfinance lending as well as higher operational costs for doing the business; however, a number of risk mitigation options are now available to such MFIs.

Since the microfinance sector has been a seller’s market and consumers with no alternative were receptive to any financing options offered to them at the seller’s (microfinance institution’s) conditions. The microfinance sector is still largely an unexplored world with tremendous potential and it was eventually realized that microfinance clients need to be served in new ways, with new tools and products.

Initially, a number of microfinance institutions, some with a view to make quick money and others willing to make a positive difference, entered the field with great ease and aplomb but little or no tactical tools to assure and sustain their growth. These players having suffered from a lack of efficiencies and without operational controls or risk discipline indulged in wayward financing that not only harmed themselves, but also their clients.

However these experiences underscored that the latest challenges for the microfinance business world were:

• Risk management,
• Ever-increasing operational expenses,
• Outreach to far-off areas
• Difficulties in repayment process, and
• Loan recovery processes.

Therefore, issues like business efficiency, reduction in operational costs, software development and communications are becoming increasingly relevant to the success of microfinance.

There are two ways to overcome these challenges:

• Invest substantially in relevant business areas which, at the end of the day, would affect return on investments (ROI), or
• Engage third party players that offer specialized services related to overcoming these challenges.

Whichever path is taken, it can be safely assumed that today, for the success of any microfinance business model, the role of third parties is becoming increasingly important.

Similar to commercial banking, the dynamics of microfinance needs better technical tools for almost every step of the model, be it evaluation of prospective borrower’s profile, monitoring of repayment schedules, anticipating impending threats and taking remedial measures.

Understandably, credit bureaus are well positioned to fill in this void as they have the infrastructure in place and by adding information regarding microfinance borrowers and other clients, credit bureaus can offer to significantly reduce credit risk for microfinance institutions. Real time integration between credit bureaus and MFIs is enabled through the telecommunications sector, which also have a role to play in enhancing service outreach while controlling transport and other costs. Mobile banking can significantly lower the cost of delivering these services, as stated in a recent CGAP report.

In today’s business, manual or semi-computerized environments in microfinance institutions is a recipe for disaster. Only sound office management policies and operational controls can ensure effective risk management and reduction in administrative expenses. However, improving business efficiency often requires investment in software development and communications and that is where the real obstacle lies, because capital cost of such inputs is beyond the capacity of most microfinance institutions.

In such a scenario, specialized third party solution providers (be they manufacturers of off-the-shelf solutions or software hosted in the cloud) emerge as viable alternatives. These outfits have in-depth knowledge about microfinance as well as ability to service numerous customers under bilateral fee based agreements without compromising the information security of the constituents.

Such an arrangement, on one side, enables microfinance institutions to avoid related capital cost for technological implements and on the other, improves capacity building processes within the organization, and allows them to focus on their core business.

While operational efficiency and telecom related solutions are easy to handle, presently the concept of cloud computing is likely to face two major obstacles:

• local regulations for microfinance institutions vary from country to country,
• under the existing mind-set, microfinance institutions prefer to have physical control over their database.

Naturally, the first challenge is far easier to overcome than the second.

People are normally resistant to change so it would entail a long continuous awareness campaign on part of stakeholders (technology firms, microfinance investors, etc.) to change the psyche of microfinance practitioners engaged and to convince them that the emerging role of specialized third party players is going to change the dynamics of microfinance in favour of the MFIs.

Credit Scoring in Microfinance – Collecting Data and the Role of Technology

We have previously looked at the various benefits credit bureaus could deliver to microfinance clients, microfinance institutions, as well as to the entire economy, as well as ways to overcome challenges associated with credit bureaus in microfinance . This week we look at the variety of information sources used in credit scoring and the role of technology in this system.

Collecting Data for Credit Bureaus

Credit agencies typically develop credit data and risk profile based on data obtained from a variety of sources, such as banks, retailers, utility companies and government agencies; however, these sources are not always applicable in the microfinance context. The high-touch nature of the microfinance model means loan officers personally gather such information by analyzing the applicant’s business and family demographics. Even if all this information is freely available, which is often not the case, this leads to a more qualitative credit profile, rather than a quantitative credit score, giving way to accuracy problems.

Microfinance credit bureaus eliminate these problems, as loan officers instantaneously gain access to a wide array of verified information, allowing them to take well-calculated risks.

A variety of data may be amalgamated by credit bureaus, and updated regularly, to create reliable credit risk scores. These include:

Financial information about microfinance clients

• About the business: type, length, financial statements, outstanding dues to suppliers, receivables from customers, mobile banking accounts
• About the credit history: Number of previous loans (from all microfinance institutions), total outstanding loans, missed loan repayments, late repayments, on-time repayments and repayments made before schedule, nature of loan collateral, number of scheduled installments, details of previous affiliation with other microfinance institutions, nature of loan contract (group based or individual, and performance against each type of contract), types of loans taken out (housing loans, education loans), other financial products used (micro-savings, micro-insurance, etc.)
• About the family: assets (such as telephones, ownership of house), businesses run by members
• Other: any previous fraudulent behavior

Non-financial information about microfinance clients

• Identification information (to eliminate chance of fraud), family size and particulars of members
• Education and age of client, as well as length of time spent as client

Role of Technology in Microfinance Credit Bureaus

A solid information system is at the heart of a credit bureau, considering the plethora of information gathered and analyzed by these systems on a regular basis.

Microfinance Credit Bureau Architecture

The diagram briefly explains the information flows in a typical credit scoring setup (considering an external credit bureau is involved). Initially, the microfinance credit bureau database is loaded with information from various sources (banks, government, microfinance institutions, mobile banking firms, etc.) to form risk profiles, which are shared with loan officers from different MFIs, as and when requested. Since the communication channel is two-way, information about microfinance clients (new clients, loan repayments, etc.) is regularly sent to the credit bureau in different ways, as discussed later.

Client data is private, and is therefore sent in a secure environment where information is encrypted and password protected. At the same time, the credit bureau must ensure compliance with the regulatory framework of the company it operates in.

Nature of System Integration of Credit Bureau with Microfinance Institution

Credit bureaus can be integrated with the information systems of microfinance institutions in a manner that caters to the informational needs of loan officers. There are two basic types of system integration in this case:

• Real time information sharing: the credit bureau database can be linked directly with the core system of (large) microfinance institutions to instantaneously update the credit profile of borrowers.
• Intermittent information sharing: light-volume (small MFIs) users automatically transmit client information through internet connections in batches, at the end of the day, or when authorized. Similarly, when loan officers wish to determine a client’s credit score, they may send hundreds of queries in a single batch, or make individual inquiries. In return, microfinance institutions may simply receive blacklists of clients with poor credit scores, or detailed credit reports.

Having said this, the information system provider should preferably have a history of managing large sets of data, and attention should be paid to whether the firm has the relevant skills and capabilities of delivering such a complex project.

Reference:

Dutheil, M. (2006). Microfinance Bureaus : Balancing Vision and Pragmatic Solutions. Available: info.worldbank.org/etools/library/latestversion.asp?235943. Last accessed 2, April, 2010.

ATMs in Microfinance – Part I

During the last decade, microfinance has explored new horizons thanks to innovations in the field of technology. One such innovation is branchless banking, which covers three distinct mediums relevant to microfinance – mobile banking, point of sales devices and finally, ATM networks. This article covers the third element, highlighting the role played by ATM networks in the microfinance sector.

Functions and Features of ATM Networks in Microfinance

ATMs have traditionally been associated with stable financial lifestyles of the medium and upper class; however, that is beginning to change as microfinance institutions (MFIs) leverage the outreach of these machines. Microfinance clients often reside in disparate a rural location, which makes it difficult for loan officers to reach them. Mobile banking services (such as M-Kesho) and POS devices (as in Brazil’s case) may solve the problem, but ATMs have their own role to play here.

MFIs can partner with existing ATM networks (Banco Ademi, Dominican Republic and Nationlink, Philippines) or setup their own system, in order to distribute loans and provide constant access to the client’s savings account. ATMs can also be used to accept deposits on behalf of loan officers and banking agents (used in POS-based microfinance solutions). The benefit using this system have been described later.

Customers typically need a smart card to avail these services, but if an ATM network collaborates with a mobile banking solution, clients may draw cash from on the basis of their mobile wallets (yuCash, Kenya).

Getting the ATM Solution Right

Developing an ATM channel to offer financial services to the poor is no easy task. Here are some factors microfinance institutions need to look at to ensure the ATM delivery channel rolls out properly.

• System integration – a proficient system development team, preferably with expertise in the microfinance sector or a related area, should be contracted to provide a capable technology platform, adequate support and troubleshooting. The ideal technology solution would allow various microfinance institutions to hook on to the ATM network, which means hardware and software interoperability of the database is key. This is essentially a cloud computing model, which has many benefits to offer.
• Cost Management – ATMs are expensive compared to POS networks and mobile banking and microfinance institutions may pause for a moment to consider the cost implications of selecting this delivery channel. There are two options available to cost-conscious MFIs in this regard:

Leverage an existing ATM network – the cost of system integration and service charges will still be present, but the colossal setup cost will not apply.

Approach low-cost ATM manufacturers – recent developments in the Indian financial sector have led to the creation of low-cost ATM machine by Vortex. It uses “about as much electricity as a 70-watt lightbulb. Backup batteries and solar panels can keep it online if the grid fails. Vortex installed a biometric touch pad to combat fraud and assure villagers new to banking that their money is safe.” This machine costs 35% of the typical market price of 20,000.

Next week’s post lists three other important factors that need attention when rolling out an ATM network from the financial inclusion perspective, and lists a few benefits of using ATM networks as a means of reaching the masses.

Technology and Microfinance Services Part II: International Remittance

Migrant worker sent over $550 billion in remittances to their home countries in 2008, which is almost 20 times the total US budget for international aid. No doubt, international remittance services offer a lucrative opportunity for microfinance institutions (MFIs) and mobile banking operators because most workers rely on informal methods to send money home since they lack access to banks.

To offer international fund transfer services to clients, MFIs and mobile banking operators must leverage linkages with money transfer operators (MTOs) within migrant-sending countries (Pakistan, India, Philippines, Bangladesh, Mexico, Poland, etc.) as well as within migrant-receiving countries (Saudi Arabia, USA, Australia, Russia, Germany, among others; see map). Since this post series is about the role of technology in microfinance services, this particular article limits itself to international remittances. (Part 1, which looked at the different technological elements of mobile banking, is a supporting post.)

Basic Requirements of Information Systems That Handle Remittances

Any effective remittance system must possess the following capabilities (Hastings, 2006):

Managing large volumes of low value transactions at low costs

Ensure speedy delivery of funds across the globe

Ensure safety and privacy of transaction orders (encrypted files are sent through different servers to communicate details about credit card numbers, bank account numbers, remittance amount, subscriber’s mobile phone number, etc.)

Interlinking with different MTOs (microfinance bank, exchange firms and money service bureaus, such as Western Union, Dollar East, MoneyGram, etc.) and clearance houses in numerous countries.

Getting Money From Customers

Customers can send remittances in a variety of ways, some of which are:

Visit MFI in person and hand over funds that are to be remitted,

Use their mobile wallets to transfer funds internationally (see previous article on mechanics of mobile banking), and

Deposit cash through specialized kiosks or extensive ATM networks electronically integrated with a variety of MFIs (details in next week’s article).

Processing in Banking Hub

Transaction details are conveyed to the information system so they may be processed along the following dimensions.

Service pricing: Each MTO has a unique service charge for different countries, and an MTO’s information platform must select the most economical option for each transaction. The World Bank has published a list of remittance prices across the world for various MTOs, which individuals as well as MFIs can leverage.

Exchange rate handling: banking systems (of the remittance-sending bank) must also determine the most favourable daily exchange rate, which varies from MTO to MTO by a few decimal points. (These decimal points make a big impact when the aggregate transaction size is large.) Exchange rates also come into play when MFIs deposit funds as floats in their bank accounts with various banks in the remittance-receiving countries.

Communicating transaction details: payment instructions and details (credit card number, account number, amount, receiver’s mobile phone numbers, etc.) are sent via the internet to the partner MTO’s system. If the remittance-sending MTO relies on its own processing system, a bridging interface may be used to connect the two portals, or the sending partner’s interface may suffice on its own.

Account settlement: the final account is settled by the core banking system (through an auxiliary application system, in the case of mobile banking – read more) behind the scene as the individual draws money out of the system. There are two ways this transaction is finalized:

Pull transaction: sometimes, a remittance-sender may not specify a bank from which his/her family can collect the money. In that case, the MTO stores transaction details and instruction in cloud computing system which can be accessed by various banks in the remittance-receiving country (provided the MTO owns bank accounts into those institutions). All transactions are pooled in the cloud and ‘pulled’ individually by banks as needed.

Push transaction: when remittance-senders specify the receiving bank, MTOs simply push the transaction instructions to that bank.

Compliance: lastly, information systems ensure compliance with regulatory standards related to customer authentication, documentation, reporting, fraud prevention, etc.

Giving Money to Customers

Three basic options allow the remitted funds to come under the possession of family members back home:

Place money in the relevant bank account at the microfinance institution

Deliver cash directly to individual, or

Deposit the funds in the relevant mobile wallet account, where it can be used for various purposes (read more).

This concludes the second article in the post-series about the role of technology in microfinance services. Part 1 looked at the various technological elements of mobile banking. Next week’s post will discuss how technology enables the setup of ATM networks and POS terminals in microfinance.

Reference:

Hastings, A. (2006). Entry of MFIs into the Remittance Market: Opportunities and Challenges. Available: http://www.google.com/url?sa=t&source=web&cd=1&ved=0CBQQFjAA&url=http%3A%2F%2Fwww.microcreditsummit.org%2Fpapers%2FWorkshops%2F23_Hastings.pdf&ei=G2-STM6YNc6XceeSxLUG&usg=AFQjCNED_bGYoqf7J0NvrtI-4NrIO. Last accessed 10th Sept

Looking at Technology in Microfinance from an Investors/Donors Point of View

We have previously covered the role technology plays in reducing costs and improving the efficiency of microfinance institutes, and following the drift, this article explores the microfinance investor’s take on technology.

It is in the best interest of investors to emphasize the development of a microfinance institution’s (MFI’s) core systems through capacity building measures such as employee training, management information system (MIS) deployment, vertical and horizontal integration, knowledge development, external alliances, governance frameworks, and the list goes on. Although expanding outreach and/or enhancing efficiency may be an interim measure , an increase in shareholder value is the end goal from an investor’s perspective.

A recent report by CGAP about the microfinance repayment crises in Morocco, Pakistan, Bosnia and Herzegovina, and Nicaragua, adds meat to this argument. The study reveals weak information systems, among other factors, exposes microfinance institutions to the dangers of fast paced client and portfolio growth. Interestingly, the global economic recession was only a secondary cause of the repayment crises.

This ‘technology-funder’ relationship works in inverse too; microfinance institutes stand a better chance of attracting funds from donors, banks, individual investors and venture capital firms if they show a higher degree of transparency, have good performance results and decent back office systems (e.g. management information systems – or MIS – and governance structures) to support rapid growth of clients, products, employees and markets, and to communicate performance data to funding partners. This not only reduces the investment risk, but also helps gain the attention of investors and donors looking for better returns or high impact.

In this context, Triple Jump and Developing World Markets, are just two investment funds specializing in microfinance that follow this strategy. Despite this, MFIs resist the idea of full disclosure:

… MFIs may not have the relevant data to report or may not have the tools
(MIS), or the time (fast growth, time pressure) to provide it. Also, MFIs have no incentive to report any data as long as they benefit from available donor funding.
Kulik, N and Molinari, P. (2004). Sustainable Microfinance and Technology . Ford Motor Company Fellowship.pg 20.

To put this into perspective, back in 2000, only 200 microfinance institutions (MFIs) out of several thousands, submitted financial reporting data to the MIX Market database, and even though this number drastically improved to over 1200 in 2008, last year, only 786 MFIs reported their performance figures.

To improve the flow of data between microfinance institutes and investors, several microfinance rating agencies have been established to look at specific financial and non-financial indicators of MFIs. Most calculations for quantitative indicators require the availability of detailed data that information systems promptly provide. For instance, MicroRate’s financial performance measures include Return on Equity (ROE), Portfolio Yield, Portfolio at Risk, Operating Expenses, Net Operating Margin, Average Loan Size, Percentage of Write-Offs, Loan Provisioning as a Percentage of Portfolio at Risk, and the Current Ratio, to name a few (Source: rating report on ABA SME, Egypt).

No doubt, investors and donors have a fundamental role to play in the establishment and progression of core microfinance systems, and the recent series of Information System Conferences arranged by CGAP reveal the following thoughts:

“Donors and investors can:

• Require MFIs to provide feedback on (technology) vendor and solution (information system)
• Enforce minimum reporting standards
• Invest in IT companies that focus on MFIs
• Encourage and incentivize partners to invest in technology, as a mean to accurate and transparent reports
• Incentivize, through funding, the usage of technology and automated reporting
• Work with partners to develop and implement technology strategies and sound selection of back office solutions
• Allocate funding to procurement/support of back office systems and capacity building in management and maintenance of them.
• Impose funding conditionality related to improvement and standardization of MFI processes and systems
• Develop a robust diagnostic to identify MFIs that are most likely to benefit from support in back office systems…then focus on those MFIs who wish to scale and are not yet big enough to fund their own investment in this area.”

Read full summary of all recommendations.

Other thoughts:

Influence MFIs to adopt lending policies that are less ‘’risk centric’’ and be more ‘’reform oriented’’.

By lowering their financing charges MFI will avert the risk of being labeled as a reformed replica of traditional loan sharks.

This concludes the series of posts about the role of technology from the investor’s perspective. Next week’s post will look at how technology is changing the dynamics of the microfinance sector.

Financial Perspective: Achieving Sustainable Growth in Microfinance – Part IV

This is the fourth part of a four-post series that discusses capacity building measures which microfinance institutes (MFIs) must take to ensure their high growth rates are sustainable.

Accounting and Auditing

Managing information that will improve the accounting and auditing functions of microfinance providers.

Problems related to the accounting and auditing functions of high-growth MFIs are rather straight-forward:

Quick disbursement of larger loans may present difficulty in maintaining accuracy and transparency,

Rapid rise in client size, branch network, and loan portfolio can flood poorly developed or manual accounting and administrative systems.

Each microfinance product (business loans, housing loans, consumption loans, micro-savings, micro-insurance, etc.) requires unique handling in the accounting system.

MFIs need to keep track of their own costs and performance, and ensure their own creditors and investors get the return due, in the form of interest or profit.

Growing delinquency rate as a result of poor credit control.

As expected, these points stem from decisions about marketing, human resource, and internal control functions because they all impact an MFI’s bottom line. The solution to these problems, therefore, is twofold:

Establish automated reporting and auditing mechanisms that bring any anomalies or problems to the attention of managers, and then,

Rectify the main causes of these anomalies and problems (mentioned under human resource, internal control and marketing solutions in earlier posts).

The first point is detailed below:

1. Regular Reporting About Various Business Areas

The management information system must be programmed to generate daily, weekly, monthly and yearly reports about managerial and financial data, such as:

Loan portfolios of individual clients, workers, branches, and markets,

Market penetration statistics,

Client data pertaining to geographic concentrations

Credit ratings of each client, from internal and external credit information bureaus,

Interest receipts and dues (loan tracking)

Late payments, overdue loans portfolio and updated ‘portfolio at risk’ figures,

Provisions for bad debt,

Loan write-offs, against each client and market, and

Performance of each product, etc.

Accurate and timely reports summarize a microfinance provider’s overall performance and highlight critical trends, specifically in terms of loan delinquencies, which serve as a warning against the threat of a repayment crisis. Alternatively, positive trends can be discovered, such as under-served markets, which promise to yield long term benefits for MFIs.

2. Internal Audit and Credit Risk Management

MFIs can minimize the frequency of deliberate errors (fraud, covering poor company performance or preferential treatment of certain clients), as well as accidental mistakes (during manual bookkeeping), if they follow strict internal auditing practices. Once full disclosure of financial performance, accounting policies, internal controls and risks are out in the open, managers can quickly take control and rectify the situation.

3. Delinquency Management

Although delinquency management is largely the function of internal credit controls (minimizing defaults), a small part of it actually falls within the financial terrain of ‘determining a sustainable interest rate’. Calculating the cost of credit to the poor is a complex task since it depends on various factors, such as operational costs, cost of funds for the MFI, contingency reserves, tax expense, credit rating, and profit, etc.

Furthermore, once interest rates have been set, possible variations on an individual basis may be necessary, depending on risk or other factors. For instance, after natural disasters strike, some borrowers may request that their loans are either rescheduled, or waived altogether, or even that new loans are distributed to cover the loss.

MFIs must realize that such restructuring often conceals poor portfolio quality, and unless robust information systems are in place, trends in delinquencies will keep rising, until the organization is faced with a full-fledged repayment crisis, as in Pakistan, Nicaragua, Bosnia and Herzegovina and Morocco.

This concludes our series of posts about the role of technology in ensuring sustainable growth for MFIs. The next blog entry will discuss the importance of management information systems in delivering cost savings and bonding together the microfinance provider’s business. You can previous parts on the following links:

Internal Control Perspective: Achieving Sustainable Growth in Microfinance – Part III

This is the third part of a four-post series that discusses capacity building measures which microfinance institutes (MFIs) must take to ensure their high growth rates are sustainable. Read Part 1 (Marketing Perspective) and Part 2 (Human Resource Perspective).

Other Non-Financial Internal Matters

Managing information that will improve internal controls, specifically, credit discipline of microfinance providers.

1. Client Analysis and Selection

Short-term incentive schemes (mentioned in the last post) encourage loan officers to acquire as many clients as quickly as possible, and therefore, compromise on quality. Instead of making them more efficient, employees may deliberately shorten or ignore rigorous loan approval procedures because following them takes time, and strict guidelines may reject several applicants. Poor decisions are made as little consideration is given to:

Crucial facts of loan requests,

Repayment capacities of clients,

Viability of business plans, and

Credit history and credit risk.

Some solutions are as follows:

Establish detailed and sound credit policies and procedures, and

Automate approval process so all steps are followed and special concessions are not possible without managerial approval.

2. Multiple borrowing and Credit Pollution

The traditional rule of ‘one loan per client’ is overlooked as microfinance providers compete for a limited customer base in saturated markets. The alternative is to search for new clients in other markets, but that option is more costly in the short-run, and therefore, less appealing. As a result, microfinance shifts from a supplier’s market to a buyer’s market and customer bargaining power rises, because of which, three problems can arise:

Reduced incentive for client to invest loan money into productive uses (because a he/she can easily take out a second loan to pay off the first),

Clients may be inclined to borrow more than they can repay and become over-indebted (simply because they have access to additional funds), and

Clients will not worry about defaulting and losing their credit history with their MFI (because they can get a new loan elsewhere and build fresh credit histories with other MFIs).

Some solutions are as follows:

Establish a centralized credit bureau to gather data about clients, based on their incomes, businesses, occupation, family size, age, present and past loans, skills, etc.  MFIs must be given quick access to this information to make timely, informed decisions that will come in handy at the Client Analysis and Selection stage, mentioned above. (Note: The topic of credit bureaus in microfinance is extensive and complex and deserves an individual post, which will come soon).

Program the organization’s information system to track more than one loan per client (in cases where client’s repayment capacity is adequate).

3. Lax Credit Monitoring and Recovery Policies

Traditionally, loan officers visit clients once a week, or conducted weekly group meetings to work out possible problems and to collect loan installments. However, as MFIs quickly add to their client base, these tasks present logistical and economic problems. Therefore, managers often reduce the frequency of field visits or deploy external agents to conduct group meetings and collect money on the MFI’s behalf. As this responsibility is relinquished to non-employees, so too is control over the process and this decentralization can lead to the following problems:

External agents are in a position to amass more influence over borrowers than the MFI itself (which can be dangerous if used against the microfinance provider), and

Non-compliance with credit procedures, along with possibility of fraud or transactional errors.

Some solutions are as follows:

Install mobile banking solution to deliver cost savings and efficiencies (permit repayment of microloans through mobile phones),

Set up automated payment terminals that reduce frequency of field visits for collection purposes, and

Generate reports that highlight clients who missed payments, so loan officers can prioritize their visits.

4. Poor Informational Flow Between Organizational Functions

As microfinance providers spread out to accommodate more clients, products, workers and markets, they need to efficiently gather and digest masses of information for various purposes, including those mentioned under marketing and human resource issues. Naturally, a manual communication and reporting system will crumble within no time because for the MFI to be responsive and successful, information needs to move between various functional areas and departments promptly, if not in real time.

The solution, of course, is to develop an extensive automated information system.

The next, and last post in this series will discuss various problems a high-growth microfinance provider faces in the areas of auditing and accounting. Read Part 1 (Marketing Perspective) and Part 2 (Human Resource Perspective).

Human Resource Perspective: Achieving Sustainable Growth in Microfinance – Part II

This is the second part of a four-post series that discusses capacity building measures which microfinance institutes (MFIs) must take to ensure their high growth rates are sustainable. Read Part I (Marketing Perspective) here.

Human Resource Related Issues

Managing information that will improve the human resource function.

A human resource information system can offer detailed reports on various elements of human resource management, and therefore, help managers prevent various issues that emerge with rapid expansion of a microfinance provider’s business:

Credit: nasaimages.org

1. Deficient Human Resources

The speedy penetration of an MFI into current or new markets requires an instantaneous rise in workers (loan officers, branch managers, administrative staff, etc.) to handle more clients, products and branches. Once the necessary appointments have been made, MFIs are eager to send workers out into the field, and hence, they resort to shortening the required training period of 3 to 6 months. The organization ends up relying on poorly skilled workers who are unable to analyze the cost and benefits related to each client, product and market, and consequently, risky and misinformed judgments are made.

Some solutions are as follows:

Maintain an updated profile of each loan officer’s capabilities (formal training, qualification details, skills, and past experience),

Determine areas that need improvement through various resources available (books, CDs, other workers, etc.), and

Automate certain management processes to ensure better managerial control.

Identification of market trends through analysis of sales figures, based on which managers can quickly make lucrative choices.

2. Short-term and Commission-based Compensation System

Some incentive schemes reward loan officers for the monthly or quarterly growth in their client base and the quality of their loan portfolios. This approach is more staff-centric than customer-centric, because it not only leads to poor analysis of customer risks and needs prior to the approval of loan applications, but also results in hostile credit recovery methods by loan officers (as mentioned in the previous post).

Some solutions are as follows:

In-depth analysis of a loan officer’s portfolio and performance to determine ‘real quality’,

Remove or dilute detrimental and conflicting compensation policies,

Develop robust credit risk management mechanisms, and

Take regular client feedback to check performance of loan officers.

3. High Turnover Ratios

Microfinance providers in competitive markets usually face high turnover ratios because of soaring demand for skilled workers. As new entrants expand into different markets, ‘market followers’ try to attract workers who have already been extensively trained by new entrants, leading to the following inconveniences:

Instability in human capital of new entrant as employee retention rate wavers,

Severe shortage of skill, and

Significant waste of time and money for the new entrant, as benefits of investment in human resource is reaped by competitors.

Some solutions are as follows:

Create compensation programs and HR policies that promote worker retention and improve employee loyalty and morale,

Analyze costs and benefits associated with high turnover ratios, and minimize losses,

Identification of strategic job families that must have back-up human capital, i.e. identify positions that must be filled at all times and create succession plans, and

Introduce job rotation programs as a tool for employee motivation and growth.

4. Job Descriptions of Middle Management

As the top management of a high-growth microfinance provider becomes involved in public relations with donors, investors and regulators, the task of supervising the expansion of an MFI’s operations is handed down to the middle management. Since most position holders in the middle management are promoted after working as loan officers, they lack the experience essential for dealing with the organization’s forays. Consequently, haphazard managerial control may ensue as complex strategic changes to policies and processes are required to sustain developments in clients, lending portfolios, products, branches, external agents, markets and employees.

Similarly, the job responsibilities of junior officers may be expanded to handle additional administrative tasks, and if delegated incorrectly, certain workers may end up overburdened with work.

Some solutions are as follows:

Set up robust and well-integrated information systems that translate the MFI’s strategy into automated operational mechanisms,

Create well documented job descriptions that match each worker’s experience and expertise (this point is linked to the solutions for Deficient Human Resources)

Generate periodic work plans, budgets and other reports that monitor and evaluate the performance of various internal and external organizational elements, and assist managerial decision making,

The last component of technology (generation of various periodic reports) assists in solving problems related to internal control and accounting as well, as we shall see in the next two posts.

This was the second part of a four-post series that discusses capacity building measures which microfinance institutes (MFIs) must take to ensure their high growth rates are sustainable. You can read the other three parts of this series at the following links:

• Marketing Perspective: Achieving Sustainable Growth in Microfinance – Part I
• Internal Control Perspective: Achieving Sustainable Growth in Microfinance – Part III
• Financial Perspective: Achieving Sustainable Growth in Microfinance – Part IV.

Marketing Perspective: Achieving Sustainable Growth in Microfinance – Part I

It has already been established that microfinance institutes (MFIs) who seek profits through aggressive growth of clients, are at risk as their systems and controls begin to strain under the pressures of expansion. CGAP recently revealed that MFIs in the four countries facing repayment crises (Nicaragua, Morocco, Bosnia and Herzegovina, and Pakistan) enjoyed years of high growth, and then developed vulnerabilities in the following areas:

• Marketing function – rapid rise in client base and delivery channels, steep business targets without laying emphasis on long term client relationships with micro entrepreneurs.
• Human resource function – deficient human resources, short-term & commission-based performance incentives, high staff turnover ratio, and inability of middle management to handle growth of microfinance institute.
• Other Non-Financial Internal Matters – lopsided & disorganized loan approval processes, widespread multiple borrowing and credit pollution, lax credit monitoring and recovery policies of microloans, poor informational flow between organizational functions.
• Accounting function – unsuitable accounting function, poor risk management, incomplete internal audit, and inadequate delinquency management.

Avoiding such hazards is a matter of management wisdom, rather than luck. Proper capacity building, led by an efficient information system that supports the MFI’s strategy and integrates all business processes (finance, marketing, human resource, technology and operations), will ensure sustainable growth due to prompt recognition of threats and opportunities. Various functional pitfalls, as well as their solutions, which have been gathered from the CGAP report and other sources, will be presented through a series of blog posts over the next few weeks.

Marketing function

Managing information that will improve the marketing function of microfinance providers.

1. Sudden Expansion in Client Base and Delivery Channels

With a rapid rise in client base, MFIs need to deal with more individuals, groups, as well as micro enterprises in new locations, through different delivery channels. Each one of these client groups have unique needs, backgrounds, religions, political opinions, working styles, skills, etc. and microfinance providers must be privy to these characteristics so customers can be better served. In other words, high growth MFIs must quickly face the daunting task of information logistics associated with micro-segmentation as its finest.

Some solutions are as follows:

Keep track of customer details and behavior through an information system (both formal and informal) and use it to devise Customer Relationship Management programs,

Link this information system (customer database) to a credit rating bureau,

Detailed analysis of market shifts to identify strategic opportunities and threats, and

Regular review of product performance and value proposition.

Identification of high-value and profitable clients that can be focused on to generate profits.

Details of seasonal spikes and troughs in demand to help the development of customized products.

2. Business Targets and Client Relationships

The high-touch nature of microfinance surges the importance of client relationships. Loan officers regularly visit clients at their homes or in groups, not only because clients value personal relationships over professional ties, but also to ensure everything is in order at the client’s end. Naturally, this becomes difficult and costly once the number of clients balloons up.

Furthermore, workers are rewarded for the quality of their loan portfolios (default rate, loan write-offs, etc.) which often leads to aggressive credit recovery practices by loan officers who are primarily concerned with their own performance, instead of the long-term welfare of struggling clients. As a result, the quality of customer service deteriorates, relationships between clients and MFIs become unsustainable, and credit discipline takes a toll (which will be discussed in a later post in this series).

Some solutions are as follows:

Search for cost savings through technology-led operational efficiencies and not by shifting to a ‘low-touch’ model, which sacrifices control and monitoring,

Establish good quality client service procedures and marketing practices relevant to microfinance,

Regular assessment of social performance(feedback and surveys) to determine client satisfaction levels,

Install appropriate credit  risk management tools to create specialized products and credit recovery procedures for high-risk clients,

Integrate compensation policy with risk management mechanisms, and

Analyze client retention and acquisition rates to determine how much is sustainable.

This was the first part of a four-post series that discusses capacity building measures which microfinance institutes (MFIs) must take to ensure their high growth rates are sustainable. The other three posts of this series can be read at the following links:

• Human Resource Perspective: Achieving Sustainable Growth in Microfinance – Part II
• Internal Control Perspective: Achieving Sustainable Growth in Microfinance – Part III
• Financial Perspective: Achieving Sustainable Growth in Microfinance – Part IV.

Technology is a Crucial Element for Microfinance

Intelligent design is the answer.

Internal Control in Microfinance

In certain economies, the microfinance sector is at the risk of implosion as reckless growth in lending portfolios of microfinance providers has brought on a repayment crisis, marked by high default rates. These incidents demonstrate that mere growth is lethal if it is not backed up by institutional and technical capacity building to deal with the growth. Prudent policies and procedures, which integrate the expansion of each organizational discipline, go a long way in protecting microfinance institutes from biting off more than they can chew, and risking the impairment of their loan portfolios and the well-being of their clients. As a result, MFIs must start investing time and money into strengthening internal control systems that are backed by appropriate technology solutions.

Improving Management and Generating Returns for Investor

Technology is more intrinsic to microfinance than we realize. Impressive repayment rates have now caught the eye of investors who are willing to provide much needed capital in return for social and financial gains on their funds. Unfortunately, since a majority of microfinance providers rely on manual bookkeeping, this high-touch, volume-based business model prevents them from gaining efficiencies and keeping costs under control as their client base grows. The alternative sources of profit are higher interest rates and service charges, but they are undesirable in the social context of microfinance.

One solution is to adopt scalable microfinance information technology that not only delivers cost savings, data security but also provides absorbs masses of data in order to provide accurate and timely reports for better managerial decision-making. Such information systems may be developed in-house or by an external vendor, which enables microfinance providers to focus on their core business.

Serving Needs of Micro Entrepreneurs

Speaking of core business, MFIs are eager to explore different geographical markets and cater to each segment’s varying needs with customized products. The explosive growth of mobile banking in Sub-Saharan Africa is a telling example of how the right strategy, backed by the right technology, can open new horizons for microfinance providers. Specialized information systems not only cater to each MFI’s unique processes and each market segment’s nuanced characteristics, they also allow MFIs to experiment with product elements and tweak them to suit client needs.

Managing Credit Risk

Another tool that ensures MFIs expand in a manner that is cautious enough for clients, yet rewarding enough for investors, is a microfinance credit bureau. By developing risk profiles of individual borrowers, credit bureaus deliver immense short term gains, which include:

• Better understanding of clients and their needs,
• Improved Know your Customer (KYC) implementation,
• Lower cost of credit for low-risk clients,
• Product customization according to risk profile,
• Reduced transaction cost and quicker loan processing in the presence of immediate risk profiles,
• Prompt credit collection as borrowers seek to improve their ratings, and
• Better portfolio management with the removal of risky loans.

These benefits yield long term gains, such as:

Greater credit discipline as multiple borrowings are prevented,

Responsible finance, marked by better decision-making and safe portfolio growth,

Better supervision of sector by investors and regulators,

Greater availability of information, which will attract competition, and

Improve financial and social performance of the MFI itself

The role of technology in microfinance, in terms of each area discussed above, will be discovered in upcoming posts on this blog. Indubitably, the possibilities for innovation, growth and impact are immense, and the power of technology can be leveraged to deliver the ‘intelligent design’ needed to help microfinance achieve its potential.

Further reading:

Neralla, D. (2010). Adopting ASP Model for Cost Effective Technology Solution in MFIs.Microfinance Insights. 16
Dutheil, M. (2006). Microfinance Bureaus : Balancing Vision and Pragmatic Solutions. Available: info.worldbank.org/etools/library/latestversion.asp?235943. Last accessed 2, April, 2010.