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: