Due Diligence Guidelines for the Review of Microcredit Loan Portfolios: A Tiered Approach

MFIs, as presently constituted, can be quite risky propositions for investors. And, external audits, ratings, and evaluations generally fail to accurately quantify the primary risk facing those investors—that of misrepresentation of microcredit portfolio quality. The Loan Portfolio Review Tool has been designed to evaluate the accuracy of reported levels of repayment and the extent to which the MFI employs sound loan management practices. The tool has been designed around three, gradually deepening, levels of review that provide the user with ever-increasing degrees of certainty about the underlying quality of loan portfolios, regardless of how they are being reported. As such, it is flexible enough for a variety of uses and different requirements for confidence levels about reported loan portfolio quality. The portfolio review is a unique, powerful, and relevant tool designed for use by the lay-person, and does not require specialized audit or financial analysis skills. Portfolio reviews are not only critical for management, but also for regulators and the growing number of commercial investors in microfinance.

  • Tier I is a two-day field review by one analyst who meets with senior management at the head office of an MFI to assess credit policies and general documentation. This level is recommended for donor agency staff who are considering making a small grant.
  • Tier II is a two to five-day field review by one or two analysts, conducted at the branch level. It entails a qualitative assessment of credit policies, procedures, and practices, and a verification of management information system (MIS) reports. This level is recommended for appraisals, audits, and ratings related to sizeable grants or investments in an MFI.
  • Tier III is a two to four-week review by a team of local auditors to evaluate, measure, and quantify asset quality through statistical sampling and detailed analysis. This level is recommended for equity investors and regulators concerned with the soundness of an institution.

Tiers I and II can be undertaken by staff of donor agencies, microfinance promoters, and investment funds, while Tier III is sufficiently technical that those commissioning such a review might want to contract an audit firm or other organization offering the sampling skills necessary to achieve the degree of statistical representation required. Tier III can be undertaken by generalists, without a high level of statistical skills. It is not difficult, but the commissioner would risk the analysis not being statistically significant to the highest degree (although, in many cases, this level of sophistication may not actually be required). The appendix includes terms of reference for an audit firm that would guide them in the completion of a due-diligence exercise (all three tiers) and details the nature of the expected reports and opinions.

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