measuring delinquency – key best practices indicators

• In the normal case, i.e., when the loan term is not over, arrears rate understates the (delinquency/default) risk in the portfolio by as much as 81.85%.

• In the special case scenario - i.e., when the loan terms are over, both PAR and Arrears Rate provide the same measure of (delinquency/default) risk in the portfolio.

MEASURING DELINQUENCY – KEY BEST PRACTICES INDICATORS

• This is because all of the arrears amount and outstanding principal balance are equal in this case (but they need not be always).

• Therefore, as highlighted by the normal case, MFIs are better off in using the Portfolio at Risk (PAR) rather than Arrears Rate as a true measure of delinquency.


• This is because when a borrower is in arrears, the default risk (of not paying back to the MFI) not only arises from the arrears amount but also from the other amounts due (in the future) from the borrower.

• Therefore, PAR is better as it takes the entire stream of payments due from the borrower unlike the arrears rate which just takes into account overdue amount


• As noted earlier, PAR has a serious limitation in that it is affected by sudden and large increases in outstanding portfolio and/or decreases in the unpaid principal balance which can be caused in any of the following ways:

Adjusting the Portfolio at Risk Measure

CASES, EXERCISES AND PROBLEMS

• Disbursement of loans

• Rescheduling of past due loans

• Re-financing of past due loans

• Loan write-offs

• Disbursement of loans (increases outstanding portfolio but will not have an impact on the unpaid principal balance of past due loans, especially, if the repayment schedule has not begun)


• Rescheduling of past due loans (reduces the unpaid principal balance of past due loans by making them current; there is no impact on outstanding portfolio)


• Re-financing of past due loans (reduces the unpaid principal balance of past due loans by making them current and also increases the outstanding portfolio)


• Loan write-offs (reduces the unpaid principal balance of past due loans and also reduces the outstanding portfolio)



KEY POINTS - RECAP

• When the outstanding portfolio increases, then the ratio appears lower and so does the risk.

• Likewise, when the unpaid principal balance of past due loans decreases, the ratio becomes smaller and the risk appears less. But actually, the risk is still high.

• BOTH OF THE ABOVE HAPPEN, THEN RATIO DECREASES SEVERAL FOLD AND

• RISK APPEARS VERY MUCH LOWER THAN IS THE CASE

• Thus, one has to look at alternative ways of measuring PAR,


• Adjust PAR for

• re-scheduling

• re-financing

• write-offs and

• recent loan disbursements


This is given in box below

EXAMPLE


Portfolio at risk (PAR) =(Adjusted for Rescheduling)

Unpaid Principal Balance of Loans with Payments Past Due + Unpaid Principal Balance of re-scheduled loans (when Rescheduled)

Outstanding Portfolio

• Likewise, one can adjust the PAR for re-scheduling and re-financing EXAMPLE


Portfolio at risk (PAR) =(Adjusted for Rescheduling and Re-financing)

Unpaid Principal Balance of Loans with Payments Past Due + Unpaid principal balance of re-scheduled and re-financed loans

Outstanding Portfolio

• Similarly, one can adjust the PAR for new loan disbursements for which repayment is yet to begin

EXAMPLE


Portfolio at risk (PAR) =(Adjusted for Recent Disbursements)

Unpaid Principal Balance of Loans with Payments Past Due

Outstanding Portfolio – (Outstanding for Loans for which the repayment is yet to

begin)

• Finally, one can also adjust for write-offs, especially, if they have been huge.

EXAMPLE


Portfolio at risk (PAR) =(Adjusted for Write-Offs)

Unpaid Principal Balance of Loans with Payments Past Due + Write-Off Amounts

Outstanding Portfolio + Write-Off Amounts

• MFI Management should have a clear policy on re-scheduling and re-financing, as they have the potential to decapitalize the RLF portfolio at all levels.

• They could also result in the ‘multiplier effect’ whereby, after re-scheduling and re-financing of some (clients’) loans, other clients also feel that they could get their loans re-scheduled/re-financed.

Loan Re-Scheduling And Re-Financing


1) If they are used to reduce delinquency, they can spell disaster for the portfolio

2) they make a risky portfolio appear less risky3) can result in causing clients to develop a mind set

that in the event of not making loan repayments, their loans will also be automatically rescheduled/re-financed


Therefore, unless, the situation mandates, rescheduling and refinancing are better avoided as

• Only in cases where natural factors such as earthquakes, fires, cyclones, floods, drought wreak havoc on economies and the activities of micro-entrepreneurs, can rescheduling and/or re-financing be thought of as alternatives.


• The key point to note here is that apart from camouflaging the level of risk in a portfolio, such actions also reduce the loan loss provisions and reserves.

• This particularly, is not good as the level of risk still remains the same.


measuring delinquency – key best practices indicators

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