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).