How to Reduce Arrears in Microfinance Institutions

Topic :

This article from the Journal of Microfinance, addresses the pressing issue of arrears reduction in microfinance institutions (MFIs). Its author, the Team Leader of the Development Resources Team for the US office of World Vision, writes in a clear and simple style which makes this otherwise academic article accessible to both policy-makers and field-workers.

The paper asserts that reducing arrears is crucial if MFIs are to achieve self-sufficiency. MFI staff must understand the causes of arrears – whether from clients’ testing the MFI’s determination to collect, crises in clients’ lives, loans that are too large, or loans given on the basis of favoritism. Analytical tools for assessing and preventing arrears include key measures for analyzing arrears (e.g., portfolio quality ratios and performance ratios by credit officer) and financial ratio tests for determining appropriate loan size. The key to reducing arrears is to follow up late loans quickly, form strong solidarity groups, update and enforce credit policies, focus credit officers’ services in a specific geographic scope, not lend to start-up businesses, and provide financial incentives for credit officers. In critical arrears situations, MFIs should suspend lending to new clients until portfolio quality improves, as well as ascertain clients’ ability and willingness to repay in order to design appropriate strategies to pursue.

The author concludes that there is no magic recipe to reduce arrears. Often it is just plain hard work. However he does note the following:

  1. Prevention is always better than cure, so a clear understanding by the client that arrears will not be tolerated is key to keeping the situation from getting out of hand.
  2. MFIs need to have clear and effective credit poli¬cies and procedures approved by the board of directors that are followed by credit officers. If the policies and procedures are not effective, then the credit officers need to have a hand in creating new ones.
  3. Management and credit officers need to pay attention to details. The average arrears rate of each credit officer’s port¬folio should be tracked weekly or biweekly and credit officers must respond quickly to problem clients in their portfolios. Likewise the credit supervisor must respond quickly to solve credit officer problems.

A microfinance portfolio with very low arrears can, within a few months, exhibit a dramatic rise in arrears, which can destroy an MFI. It is very important that managers watch carefully that policies are followed once they are put in place. If things are not working, then the institution needs to identify the problem areas and fix them quickly. The alternative is bankruptcy. The author does not use case studies to illustrate his point, but his references range from Zimbabwe to Nicaragua.

  • Resource type
  • Author Norell, D.
  • Year of Publication2001
  • Region
  • LanguageEnglish
  • Number of pages16 pp.
  • EditionJournal of Microfinance

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