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Methodology
Microfinance Study, Part 2
9/31/2006
Lending Products Summary
• Lending products are characterized by…
– Loan amounts
– Loan terms
– Collateral requirements (or substitutes)
– Interest rates/fees
– Compulsory savings/group contribution
requirements
Loan Amounts
• Client cash patterns
– Regular (deli, grocery store, utility)
– Irregular (high-ticket items)
– Seasonal (harvest)
– Emergency (illness)
• Loan amount dependent on
– Loan purpose
– Client debt capacity
Loan Term: Why does it matter?
• If loan term is longer than business
cycle…
– Some cases, cannot access loans until
existing loan is repaid
– Tempting to spend early cash flows
• Note: 12-month loans in busy urban markets = low
repayment rates
Loan Term: Why does it matter?
• If loan term is shorter than business
cycle…
– If no savings to begin with, may not be able to
generate enough cash flow to cover loan
repayment
• SO goal is to adjust term structure to
business cycles (debt-servicing capacity of
clients)
Loan Term: Why does it matter?
• Prepayment – clients repay loans early
– The good:
• Reduce both security risk and temptation to spend
excess amounts of cash
• Reduce burden of loan installments later in loan
cycle
• Increase speed with which MFI can revolve loan
portfolio
Loan Term: Why does it matter?
• Prepayment
– … And the bad:
• Difficult to monitor, disrupting MFI cash flows
• Less interest for MFI (unless loan is immediately
revolved)
• Indicate borrowers are receiving loans from other
lenders with better service, lower rates or more
appropriate terms.
– Solution: shorten loan-term of those who
prepay often
Loan Use
• Working capital loans
– Current (<1-year) expenditures that occur in the
normal course of business
– 2 months – 1 year
• Fixed asset loans
– Expenditures made for the purchase of assets that
are used over time in the business
– Larger amount, longer term
– Higher risk; offset by legal title of asset as collateral
by MFI
• Fungibility – money used to cover other
expenses (use may be less important than
capacity to repay)
Loan Collateral: Substitutes
• Group Guarantees
– Implicit: other group members are unable to
access a loan if all members are not current in
their loan payments
– Actual: group members are liable if other
group members default on their loans
– Group guarantee funds
• Group discretion vs. MFI discretion
Loan Collateral: Substitutes
• Character-based lending
• Frequent business visits
• Risk of public embarrassment
• Risk of jail/legal action
Alternatives to Collateral
• Compulsory Savings
– Independent vs. group savings funds
– Not available for withdrawal while loan is
outstanding (for MFI use – caution)
– Opportunity Cost = return on savings – return
from business investment
– Asset-building, not just alternative to collateral
– “Prompt payment incentive” – Bank Rakyat
Indonesia
Alternatives to Collateral
• Pledging assets based on personal value
– Pledge assets whose value is less than the
loan amount (to MFI) – what is valuable to the
client?
• Personal Guarantees
– Enlist cosigners to guarantee loans
Loan Pricing
• Borrowers are empirically not price
sensitive because of limited access to
capital!
– Balance between repayment and MFI
sustainability
Loan Pricing: Four Main MFI Costs
• Financing costs
• Operating costs
• Loan loss provision
• Cost of capital
Loan Pricing: Four Main MFI Costs
• Financing costs
• Operating costs
• Loan loss provision
• Cost of capital
Loan Pricing: Financing Costs
• Outside financing
– Grant or loan?
• Compulsory savings financing
– Interest rate?
Loan Pricing: Financing Costs
• Example
– 1,000 loan portfolio
– 400 funded by internal savings @ 5%
– 600 funded by outside sources @ 10%
– Take arithmetic mean of the rates and you
get…
0 1 2 3 4 (months)
Outstanding Balance 1000 760.973 514.7751 261.1913 -6.25278E-13
Payments 269.027 269.027 269.027 269.0270452
Principal 239.027 246.1979 253.5838 261.191306
Interest 30 22.82919 15.44325 7.83573918
Payment = 269.027
Sum of Principal = 1000
Excel Model: Alternative 1
Alternative 1: Flat Interest
PV 1000
n 4
i 36% per year
i/12 3% per month
0 1 2 3 4 (months)
Outstanding Balance 1000 750 500 250 0
Payments 280 280 280 280
Principal 250 250 250 250
Interest 30 30 30 30
Payment = 280
Sum of Principal = 1000
0 1 2 3 4 (months)
Outstanding Balance 1000 766.9247 522.9125 267.45 -3.41901E-06
Payments 280 280 280 280
Principal 233.0753 244.0123 255.4625 267.4499833
Interest 46.92472 35.98773 24.53752 12.55001673
Payment = 280
Sum of Principal = 1000
The rest are done the same way , except that the payment value k eeps changing due to change in cash flows!
Excel Models
• Try the other alternatives at home, they all
basically work like the first alternative!
– Alternatives 5 and 6 incorporate compulsory
savings, meaning we need to calculate future
value of those savings at the end of the loan
term
– If savings are not held by the MFI, then the
amounts should not enter into our
computation
Effective Cost vs. Effective Yield
• “Yield refers to the revenue earned by the
lender on the portfolio outstanding,
including interest revenue and fees”
– Used to determine if enough revenue will be
generated to cover all costs
Effective Cost vs. Effective Yield
• Two main differences
– Components that are not held by (and therefore do
not result in revenue to) the lender are not included in
yield, but included in costs
– Return to lender computed based on average portfolio
outstanding, not on borrower’s initial loan amount
– If all components of loan are both costs to borrower
and revenue for lender, then only difference is
method used to annualize rate
Compounding vs. Multiplying
• Cost to the borrower
– This cost is compounded by the number of
payment periods in the year because…
– IRR is amount borrower forgoes by repaying
loan in installments (principal amount
available declines with each installment)
– Return earned per period if the borrower
could reinvest would compound over time
Compounding vs. Multiplying
• Yield to the lender
– Per period rate is multiplied
– Assume revenue generated is used to cover
expenses and is not reinvested – therefore,
average portfolio outstanding does not
increase!
Annualizing IRR
• Compounding: (1 + IRR/100)a – 1
– Where a = number of periods in one year
– Use for borrower cost
• Multiplying: IRR * a
– Where a = number of periods in one year
– Use for lender (MFI) yield
Lending in Context (Bastelaer)
• MFIs have leveraged current social
structures – termed “social capital” – to
increase repayment rates and returns
– Rotating Savings and Credit Associations
(ROSCAs)
• Group contribution to fund, distribute funds to one
individual, re-fund, repeat, dismantle when finished
– Moneylenders
– Trade credit (supplier to buyer relationships)
Lending Schemes Around the
World (as related to Lebanon ~2001)
• Mobile banks (collectors and lendors)
– Up to 100% rates on postponed payments
– 15% monthly interest (+4 extra days of
interest)
• Savings and lending associations
– ROSCAs
Lending Schemes Around the
World (as related to Lebanon ~2001)
• Group lending
– Loan disbursed to borrowers in group; peer
pressure is basic guarantee for loan
repayment
– Developed by Grameen Bank
• Group Solidarity lending
– Loan disbursed to groups rather than
individuals
– Developed by ACCION International
Lending Schemes Around the
World (as related to Lebanon ~2001)
• Group lending
– Loan disbursed to borrowers in group; peer
pressure is basic guarantee for loan
repayment
– Developed by Grameen Bank;
• Group Solidarity lending
– Loan disbursed to groups rather than
individuals
– Developed by ACCION International
Lending Schemes Around the
World (as related to Lebanon ~2001)
• Rural community banks
– Saving/lending institutions run by local
community committees
– Secure financial services; build group
solidarity; facilitate savings
– Developed by Foundation for International
Community Assistance (FINCA)
– Number of members varies between 30 and
50
Lending Schemes Around the
World (as related to Lebanon ~2001)
• Self-financing village banks
– Rural community manages village bank,
which serves the entire village, not just its
members
– Developed by the International Centre for
Research and Development in mid-1980s
– Goal is to self-sustain on savings
Lending Schemes Around the
World (as related to Lebanon ~2001)
• Credit unions/lending and savings
cooperatives
– Began operating in developing countries in
1950s
– Provide savings and loan facilities for
individuals
– Act as intermediaries in money transfers
between urban and rural areas and between
savers and lenders
Lending Schemes Around the
World (as related to Lebanon ~2001)
• Transformation lending
– Targets micro-enterprises with intention of
growing sales and revenues and number of
people employed
– Often transfers funds from banks to micro-
enterprises to transform into small businesses
Lending Schemes Around the
World (as related to Lebanon ~2001)
• Commercial and development banks
(downscaling)
– Development banks: publicly owned
institutions established to provide financial
services to specific strategic sectors (i.e.
agriculture/industry) sometimes at subsidized
rates
– Commercial banks: private institutions that
provide services to high-income clients that
run service-oriented businesses
Mozambique ~1997: Loan Term
Example
• Range from 10%-60% (nominal)
• Commercial rates: 20%-30%
• Discount rate: 12.95% (32% in 1996)