Performance indicators in - PowerPoint Presentation

Slide1

Performance indicators in microfinance

P.V. ViswanathSlide2

Learning Goals

What are the different

measures of an MFIs performance?

How can these financial

ratios

be used

to

evaluate a microfinance

institution?

Caveat: Some of the ratios discussed here are more appropriate to MFIs that are mainly involved in micro-credit.

Much of this material is taken from the Technical Guide published by

MicroRate

and the Inter-American Development Bank, as well as from

Armendariz

and

Morduch

, Economics

of MicrofinanceSlide3

Four categories of indicators

Portfolio

Quality

These ratios measure the quality of the MFIs loan portfolio. MFI portfolios are generally of better quality than those of commercial lenders.

Efficiency and

Productivity

These ratios measure the efficiency with which the MFI conducts its operations. MFI rates of efficiency are much lower than that of commercial banks because their operations are highly labor-intensive.

Financial

Management

These ratios ensure that there is enough liquidity to meet an MFI’s obligations to disburse loans to its borrowers and to repay loans to its creditors.

Profitability

These ratios summarize the overall performance of the MFI.Slide4

Portfolio Quality

Portfolio at Risk

Provision Expense Ratio

Risk Coverage Ratio

Write-Off RatioSlide5

Portfolio at Risk

PAR

= Outstanding Balance in Arrears over 30 Days plus Restructured Loans/ Total Outstanding Gross

Portfolio

It shows the portion of the portfolio that is “contaminated” by arrears and therefore at risk of not being repaid.

This ratio is relatively manipulation-free, compared to ratios such as the repayment rate which may not take into account loans that are past due.

In cases of agricultural loans, where there might be balloon payments, PAR 30 ratios may be irrelevant because there is no warning of non-repayment until the event actually occurs.Slide6

Loan Loss Provisions

A

loan provision

records the possibility that an asset in the balance sheet is not 100%

recoverable

.

Provisions

expense this anticipated loss of value in the portfolio gradually over the appropriate periods

in which

that asset generates income, instead of waiting until the actual loss of the asset is realized

. Provisions

are only accounting estimates and entries, and they do not involve a movement of cash,

like saving

for a rainy day.

Loan loss provisions charged to a period are expensed in the income and expense statement.

The corresponding

credit accumulates over time in the balance sheet as reserves shown as a negative

asset.

The

accounting transaction is

:

Debit

Loan loss

provision; Credit

Loan loss

reserveSlide7

Provision Expense Ratio

Ratio = Loan Loss Provisioning Expenses/ Period Average Gross

Portfolio

The

Loan Loss Provisioning

Expense is an income-statement number, not a balance-sheet number.

It represents the charge to income that is taken to take into account future loan losses.

For non-regulated MFIs, this may be at the discretions of the MFI and thus may be underestimated.

Even where regulatory guidelines are satisfied, an MFI could show profits by scaling back on provision expenses.Slide8

Risk Coverage Ratio

Ratio = Loan Loss Reserves/ Outstanding Balance on Arrears over 30 days plus Refinanced

Loans

This shows what percent of the portfolio at risk is covered by actual loan loss reserves.

Refinanced loans are added to the denominator because a non-performing loan can be converted into a performing loan by the simple device of allowing the borrower to extend the payment period or by refinancing it.Slide9

Write-off Ratio

Ratio = Value of Loans Written Off/ Period Average Gross

Portfolio

This ratio represents the loans that the institution has removed from its books because of a substantial doubt that they will be recovered.

Loan losses or write-offs occur when it is determined that loans are unrecoverable. Because loan loss reserves already provided for possible losses, loan losses are written off against loan loss reserves and are also removed from the outstanding portfolio. The accounting transaction is:

Debit Loan loss reserve; Credit Outstanding loans

Write-offs do not affect the net portfolio outstanding unless an increase in the loan reserve is made. When write-offs are recovered, they are booked in the income and expense statement as miscellaneous income

.Slide10

Efficiency and Productivity

Operating Expense Ratio

Cost Per Borrower

Personnel Productivity

Loan Officer ProductivitySlide11

Operating Expense Ratio

Ratio

= Operating Expenses/Period Average Gross

Portfolio

Operating

Expenses

include Personnel Expenses, Administrative Expenses, Depreciation and any other expenses necessary for the operation of the MFI.

Interest and provision expenses, as well as extraordinary expenses are not included.

This ratio measures the institutional cost of delivering loan and other services.

Operating Expense Ratios are related to loan size and portfolio size.

Similarly, rural MFIs have higher operating expenses, since their clients are more dispersed.

Hence one should be careful in comparing this ratio across MFIs.Slide12

Cost per Borrower

Ratio = Operating Expenses/Period Average Number of

Borrowers

This measures the cost of maintaining an active borrower. A borrower is an individually identifiable person who has at least one current outstanding loan. All borrowers in a group loan are counted separately.

Since the size of the portfolio is not included in the denominator as in the Operating Expense Ratio calculation, MFIs with larger loans do not automatically appear more efficient.

Pawn loans and consumer loans are excluded from the denominator, since they require far less screening and analysis efforts. (Why?)Slide13

Personnel Productivity

Ratio = Number of Borrowers (excluding Consumer and Pawn Loans)/ Total

Staff

Since MFIs are very labor intensive, this is a very important measure of efficiency.

Low staff productivity often is due to excessive paperwork.

A variant of this ratio is the loan officer productivity ratio, where the denominator includes all personnel whose main activity is the direct management of a portion of the loan portfolio; it does not include administrative staff or analysts who process loans without direct client contact.Slide14

Financial Management

Funding Expense Ratio

Cost of Funds Ratio

Debt/Equity RatioSlide15

Funding Expense Ratio

Ratio = Interest and Fee Expenses/ Period Average Gross

Portfolio

This ratio measures the total interest expense incurred by the institution to fund its loan portfolio. The difference between the portfolio yield and the funding expense ratio is a measure of the net interest margin.

Th

e funding expense ratio plus the provision expense ratio plus the operating expense ratio

determines the minimum lending rate an MFI must charge to cover tis costs.

If the MFI uses non-debt sources of finance, obviously this ratio underestimates the total cost of funds.Slide16

Cost of Funds Ratio

Ratio = Interest and Fee Expenses/ Period Average Funding

Liabilities

The denominator contains all funding liabilities of the MFI, including deposits, commercial funds, subsidized funds and quasi-capital. It does not include accounts payable, since these are short-term obligations not directly related to the lending operations of the MFI; neither are mortgage loans obtained to finance the MFIs buildings, for the same reason.

This ratio measures the average cost of the company’s borrowed funds and shows whether it has access to low cost funding sources, such as savings.Slide17

Debt-Equity Ratio

Ratio = Total Liabilities/Total

Equity

Total liabilities include everything the MFI owes to others.

This ratio measures the overall leverage of the institution. Traditionally, NGO MFIs have low debt-equity ratios, since their ability to obtain commercial debt is limited.

Most MFIs have lower leverage than commercial banks.Slide18

Profitability /Sustainability

Profitability Ratios

Return

on Equity

Return on Assets

Portfolio

Yield

Sustainability Ratios

Operating Self-Sufficiency

Financial Self-SufficiencySlide19

Return on Equity

Ratio = Net

Adjusted Income Before

Donations (after taxes)/ Period

Average

Equity

This ratio measures the profitability of the institution.

This is more important for for-profit institutions. For non-profit institutions, it can be used as a measure of commercial viability.

When comparing across MFIs, differences in accounting policies have to be taken into account.Slide20

Return on Assets

Net Adjusted Income Before Donations/Period Average

Assets

This is an overall measure of profitability that reflects both the profit margin and the efficiency of the institution, as can be seen from the following identity.

ROA = Net

Adjusted

Income/Revenue x Revenue/Assets.Slide21

Portfolio Yield

Ratio = Interest and Fee Income/ Period Average Gross

Portfolio

This measures how much money the MFI actually collected from its clients.

A comparison between the portfolio yield and the average effective lending rate gives an indication of the MFI’s efficiency in collecting from its clients.

Since portfolio yield is a cash measure, it is not affected by

accrual

accounting practices that might mask bad loans.Slide22

Operational Self-Sufficiency

OSS = Operating Revenue/(Financial Expense + loan-loss provision expense + operating expense)

Revenues come from interest and fees paid by borrowers, as well as income from investments and from other services (e.g. sales of insurance products)

The denominator measures the cost of raising capital.

It includes the interest and fees that the institution pays to commercial banks, shareholders and the other investors.

It includes interest paid to depositors.

The loan-loss provision is the amount set aside to cover the cost of loans that are not expected to be recovered.

Operating Expenses include rent, staff wages and transport costs among others.Slide23

Operational Self-Sufficiency

A value of 100% or more for OSS indicates full operational self-sufficiency; such an institution does not need outside support.

A value under 100 indicates that the MFI relies on continued outside funding to maintain its current level of operation.

However, some of the operations of the MFI may be subsidized. In order to adjust for this, we have the financial self-sufficiency ratio.Slide24

Financial Self-Sufficiency

FSS = Adjusted Operating Revenue/(Financial Expense + loan-loss provision expense + operating expense + expense adjustments).

Operating Expenses are adjusted for subsidized cost-of-funds and for in-kind donations.

Cost-of-funds are computed at market rates and the difference is added back to the financial expense.

The market rate used should be the prime rate, adjusted for the riskiness of microloans.

In-kind donations add in the cost, or fair market value, of goods and services that the MFI does not pay for but that are important to the operation of its business. This could include technical advice, training, rent, use of transport and so on

.

If FSS is below 100, the institution is considered subsidy-dependent.