We wrote last week that the direct evidence of microfinance’s impact is less than overwhelming. However, many believe that direct evidence is not needed – that as long as microfinance institutions demonstrate high “repayment rates,” they can be assumed to be improving lives. The logic goes that if a person is able to repay their loan with interest, they must have used it productively.

We believe the repayment rate doesn’t tell you nearly enough to have confidence.

Concern 1: what does the “repayment rate” actually mean?

One of the things that has surprised us, as we’ve looked into microfinance, is that we haven’t seen a clear or consistent definition of the “repayment rate” often featured on charities’ websites.

The excellent MixMarket site is a clearinghouse for standardized information from MFIs. But looking through its glossary doesn’t turn up any statistics that are clearly equivalent to the repayment rate (i.e., the percentage of loans due that are repaid on time). The closest items appear to be:

• “Loan loss rate”: the loans written off (minus any payments recovered post writeoff) divided by the total outstanding loan balance.

• “Portfolio at risk > [XX] days ratio”: the loans that have a payment past due more than [XX] days, divided by – again – the total outstanding loan balance.

One problem with both of these statistics is that they are taken as a percentage of loans outstanding, not loans due. In other words, if one takes either of these measures as the inverse of “repayment rate,” an MFI can inflate this “repayment rate” simply by growing its loan portfolio (making loans that aren’t yet due). Consider the simplified case of an MFI that has made $1000 worth of loans that are all past due, and $2000 worth of new loans that aren’t due yet. In this case it will list a “loss rate” of only 1/3, even though all of the loans due have failed to repay. This is an especially serious concern because of how common it is for an MFI to be rapidly expanding its loan portfolio. Out of 257 MFIs we examined with the relevant data, 82 have seen their portfolio grow by 50% or more in the most recent reported year, while 21 have seen 100%+ growth.

In addition, both of these statistics rely heavily on which loans an MFI chooses to “write off.” An MFI that chooses to hold bad loans on its books could have a very low “loan loss rate”; conversely, an MFI that chooses to write off many loans could have a very low “portfolio at risk” (since a loan that is written off is no longer considered part of the portfolio).

We spoke with Accion International and asked about the figure on its website claiming a historical repayment rate of 97%. We were told that this figure is calculated via “loans paid” divided by “loans due,” which distinguishes it from both of the standardized figures listed above. However, we were also told that loans can be counted as “repaid” even if they’re restructured (i.e., the terms of the loans are changed to accommodate late or incomplete repayment). Another microfinance charity, FINCA, has told us that “portfolio at risk” (discussed above) is the metric used.

Bottom line: the “repayment rate” figure is highly subject to interpretation, unless the organization giving it is very specific about how it’s calculated.

Concern 2: is a repaid loan always a good thing?

This question has been discussed at length on David Roodman’s blog about microfinance. Some concerns:

• High repayment rates could indicate coercive collection practices – especially because the responsibility for collection is often left to “lending groups” with limited oversight from the institution.
• People may be taking out more credit – and thus paying more fees – than is in their own best interest (even if they can repay the loans).
• People may be engaging in unsustainable borrowing patterns, such as repeatedly borrowing from one MFI to pay back another or oversaturating the market with their microenterprises. Roodman’s latest post on the idea of a “microfinance bubble” concludes that there is little hard evidence that such “bubbles” are occurring, but unsustainable borrowing is a possibility.

Concern 3: who is taking out the loans?

Are the people served by MFIs extremely poor? Relatively poor? Relatively wealthy? Moneylenders themselves, taking advantage of donor subsidies?

When donations are used to offer a loan at a below-market rate, a loan may be quite functionally similar to a a cash gift, especially if funds can be re-lent informally (and studies such as Portfolios of the Poor suggest that the informal market for lending is quite active).

Note that a high repayment rate could partially be the product of wealthier clients’ repayments, even if repayments from lower-income clients are less reliable.

Beyond repayment rates

Here is some of the information we think an MFI can provide to address the concerns above:

• A clear and explicit definition of “repayment rate.” Are “loans outstanding” implicitly counted as “loans repaid” (as in the MixMarket measures we discussed) or does the rate only include loans due? Can loans be counted as repaid when they have been restructured or delayed? How common and drastic are restructurings and delays?
• Information on clients’ incomes and standard of living. How are clients selected? How poor are clients?
• Information on client turnover. How often do clients leave the program, and for what reasons? (Presumably, clients would be more likely to continue taking out loans if the loans were truly beneficial for them.)
• Rigorous impact studies, which we’ve discussed at length.