Innovation · Microfinance · Opinion

Zero defaults not good for innovation

One of the key metrics tracked closely by microfinance institutions (MFIs) is the percent of the loan portfolio at risk (PAR) after 30 days. That is, what % of the loans outstanding are in arrears more than 30 days. This is viewed as an important indicator of the “health” of a loan portfolio and the health of the MFI.

In some countries, there is a perception/expectation that 30-day PAR (PAR30) should be almost zero. For instance, in India, most the high-growth organizations have PAR30 of less than 2% and some have very close to zero. This is achieved through a number of methodology implementations including manageable loan sizes/payments, group guarantee/social capital, frequent repayments, etc. In other countries (e.g. many countries in Latin America), the typical PAR30 is in the 5-10% range. There are no absolute right or wrong levels (although getting above 10% can have some potentially very negative tipping point issues), just different models in different locales.

At the recent Unitus Leadership Summit, there was an interesting discussion amongst some of the world’s fastest-growing and innovative MFIs around what the target rate for PAR30 should be. On one hand, low PAR indicates that your system is working well and you don’t have to have your in-good-standing clients paying more to subsidize your delinquent borrows. On the other hand, it is very difficult to innovate in without experimenting … and experimentation often leads to, at least, some short-term decrease in PAR as you’re ironing out the process.

Some of the innovations under development are:

  • moving from weekly to bi-weekly repayments … this is an oft-requested feature by clients as it would reduce the amount of time spent on transactions
  • individual loans instead of group loans … essentially not using a group incentive model
  • loans to men … most MFIs only loan to women
  • different repayment installment models … e.g. rather than typical equal amount of principle and interest on each repayment, offer some balloon repayment options
  • agriculture-related loans … most MFIs currently don’t provide this type of loans due to the high risk of crop failures and the seasonality factors
  • higher loan size … ramping up size of loan more quickly based on individual needs and capacities … most MFIs have fairly similar loan size increases purely based on how long you have been a borrower in good standing
  • early repayment options … requested by some borrowers who want to pay off early to lower interest payments and, in some cases, accelerate to next larger loan size
  • new financial products such as insurance

I think that we should encourage MFIs to be more innovative in developing and experimenting with new financial services for the working poor even if this results in some marginally higher default rates in the short-run as ultimately the innovations will provide more value/benefit to the clients.

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