# What does the repayment rate really tell you about the impact of microfinance?

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:

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.

• I know that micro finance can help improve lives. Unfortunately, it is vague when it comes to repayment scheme. Will it facilitate the needed assistance that has been the concept of micro finance in the first place? Or so it seemed it contradicts the very concept of micro financing.

• Taylor on October 16, 2009 at 8:55 am said:

I agree with Erik in that micro-lending and micro-credit can improve lives. Look at the pioneer of credit, Muhammad Yunus, who won the Nobel Prize in 2006 (I believe it was) for his efforts to promote small business and financial independence in Bangladesh.

That said, you ask some very real questions in this article. Questions that must be asked. What is the truth behind these repayment rates, is micro-lending all it’s been made out to be by its proponents, or are there unsustainable borrowing practices beneath the surface?

I’d really like to see some stats on the demographics of the borrowers. That might give us some better insight.

• The loan loss rate is divided by the average loan portfolio, not outstanding loans, as you state above. This is because write-offs are an income or ‘flow’ variable. Growth in the portfolio is also reflected indirectly by use of an average. Regardless, if I understand your example, the loan loss rate would actually be 0 since no loans (appear to) have been written off at that point in time.

PAR is divided by the outstanding balance since it looks at delinquency at a single point in time, rather than over a period. Outstanding loans includes all loans on the balance sheet at that point in time, whether payments are late or not. In the example above, the PAR ratio would be 1/3 (= 1000 / (2000 + 1000)).

Microfinance reporting standards generally include renegotiated loans in the PAR ratio. For more, see here: http://www.seepnetwork.org/resources/Measuring%20Performance%20of%20MFIs%20Framework.pdf

• Holden on January 11, 2010 at 9:24 pm said:

I hadn’t realized that “average loan portfolio” refers to the average portfolio over the same period for which writeoffs are reported. (This makes sense to me; it’s just that the term isn’t defined on the page and I hadn’t put two and two together.)

I also misspoke when giving my example – I should have said “written off” rather than “past due.”

I am not sure how commonly the “portfolio at risk” includes renegotiated (but not past due according to the new terms) loans. At least one MFI has indicated to us that it does not report in this way.

As stated in my response to your other comment, I still feel donors are being misled.

• Rachel on January 16, 2010 at 2:12 pm said:

Holden.. I am becoming a real fan of your blogging. Here in East Africa, the average microfinance interest rate if 15-24% which would be considered obscene by western standards for an average bank loan. In addition, most of the loans made available to rural sector communities are too small to generate enough revenue to pay back the loan and the interest within the defined timetable. I regularly see MFIs launch schemes with donor funding that are badly planned without well defined assessment / vetting or offering the necessary extension services needed by the communities they target. But more often than not, I see donors choosing local MFI “partners” without the necessary experience or capacity. Yes, I still believe microfinance can be a good thing but am regularly spent into a rant when I see another badly planned scheme wasting much needed rural sector finance.

Scott.. thanks for the referral to SEEP. They have great resources and have saved me more than once.