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:

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.