Tracking Financial Performance Standards of ... - Sa-Dhan

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Tracking Financial Performance Standards of Microfinance InstitutionsHowever, in the absence of adequate historical data on default by borrowers, MFI can resort to followingguidelines to assign provisioning rate:a) National statutory bodies have their own norms for setting the provisioning rate – The Reserve Bankof India has stipulated norms for classification of loans in NBFCs.b) International best practices recommend values for various loans categories which are as follows:Status of LoansReserve RateRegular 0%1-30 days past due 10%31-60 days past due 25%61-90 days past due 50%91-180 days past due 75%181-365 days past 90%> 365 days past due 100%c) Sometimes, as in the beginning of an MFI operation, it may not be possible to have an aging schedule,as loans may still not have become due. In such circumstances, when having an aging analysis is rathernot applicable or not possible (due to lack of data), using the internationally recommended norm of 3percent of loans outstanding as the allowance could be implemented.5. After assigning provisioning rate for each age (risk) category, now multiply the volume of loan outstandingin each category with corresponding provisioning rate. This will give the amount to be provisioned (forloan loss) under each risk category.6. Now add up all provision amounts under each age category to get the overall provision amount. To get theoverall provision rate, divide the overall provision amount by total outstanding portfolioThe entire process calculating loan loss provision is summarized below with an illustrative example.Calculating loan loss provision requires an aging schedule, allocating probabilities (reserve rates) for likely loanlosses for each category of loans and then multiplying the volume of loan outstanding in each category by theprobability and adding it all to get the provision amount (or even the overall provision/reserve rate for whichone would have to divide by the outstanding portfolio).I II III IV = (II*III)DescriptionLoanProvision AmountProvision RateOutstandingAdding to ReserveRegular Loans 100,000 0% -Loans with overdue for < 30 days 10,000 10% 1,000Loans with overdue between 31-60 days 10,000 25% 2,500Loans with overdue between 61-90 days 3,000 50% 1,500Loans with overdue between 91-180 days 1,000 75% 750Loans with overdue between 181-365 days 4,000 90% 3,600Loans with overdue for >365 days 5,000 100% 5,000Total 133,000 - 14,350The Total Provision Amount is in the last row of column IV and it equals to Rs. 14,35060
Constructing Loan Repayment Schedule Aging Schedule and Loan Portfolio Report for an MFIThe Provision Rate = Column V Total = 14,350 x 100 = 10.789 % = 11% (approx.)Column II Total 133,000Let us assume that this is provision rate for the most recent years and also consider that the provision rates forthe previous two years (before this year) are 10 percent and 11 percent respectively. Now, using the data ofthree consecutive years, average provision rate could be calculated that can be applied for the next year (forprojection or otherwise)Average Provision Rate = 11% + 10% + 9% = 30% = 10%.3 (years) 3In other words, a reference provision rate is now available based on a historical analysis of the data over a threeyearperiod. While one may want to question, the appropriate number of years to choose for calculating theprovision rate, it must be clarified that there is really no concrete scientific guideline. However, one may arguethat the last 3 years (being most representative of the current situation) are perhaps best used in calculating theaverage.The provision rate increases as loans have been overdue for a longer period – the farther a loan is from theoriginally scheduled repayment, the likelihood or probability of the loan being repaid (or recovered) is lower.Therefore, as the age of the loan, in terms of its overdue status increases, the provision rate (or risk factor) alsoincreases. Obviously, such a risk is minimal in loans that are regular – i.e., they have no overdue. Therefore, theprovision rate is listed as 0 percent. However, MFIs following more prudent norms also make provision forregular loans (in the range of 1% - 3%).While the above are intuitively appealing arguments, several key aspects need to be considered while establishingthe provision rate on historical data:a) Take for the example an MFI, where during a particular season (monsoons or otherwise), repayments maynot come in for 3 months or so – this is true of weaving and fishing (where clients go to sea). Under suchcircumstances, < 90 days overdue loans would not be at great risk because of the seasonality aspect. Clientsnormally repay the entire amount when they get back to work, often over 2/3 installments, as both examplesgiven above are high value (low volume) trades.b) Likewise, for crop loans, the same is true as crops are harvested after 90 days or so (many a time) and theargument that repayment will occur from the household income or other livelihoods has often not happened.In such cases, the very nature of livelihoods sometimes causes over dues in payment but the riskmay not be high after all. Therefore, it seems prudent to tailor the risk rates to the context and change it,if there is enough justification.c) If there is insurance for calamities and other aspects, the provision (risk) rate again could be lowered butthis must be justified.4.2.3 Accounting Entries for Loan Loss Provision, Loan Loss Reserve and Write-offsIn the previous section, we learnt to calculate Loan Loss Provision, now the next step would be to makeappropriate accounting entries for the provision In this section, we will try to learn the relevant accountingtreatment of loan loss provision and its bearing on loan loss reserve.Before we move to accounting entries, let’s take a quick re-look at the key concepts related to loan loss provisionand reserve and write-off.61
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TECHNICAL TOOL SERIES 1TRACKING FIN
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INTRODUCTION TOMICROFINANCE STANDAR
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5. PERFORMANCE STANDARDS - CONCEPT,
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ACKNOWLEDGMENTSThe need of the oper
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TermStatement of Profit and LossStr
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REFERENCESBarrel, Margaret, Michael
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