Toolkit for Loan Portfolio Audit of Micro Finance Institutions

This publication provides a best practices toolkit for microfinance institutions on how to conduct a loan portfolio audit. The authors begin from the premise that the loan portfolio is the primary income generating asset for an MFI – note that here the term MFI is broadly used and includes Micro Finance Institutions, Commercial Banks, Non Banking Finance Companies / Institutions, Cooperatives / Credit Unions and other such entities involved in delivering financial services to low income people – and it is most commonly subject to material mistakes. Most MFI failures stem from the deterioration in the quality of the loan portfolio. An assessment of the risks and inadequacies inherent in an MFI’s portfolio therefore assumes tremendous importance and this is the most important objective of a “loan portfolio audit”.

The authors highlight that MFI credit (lending) operations have unique characteristics that portfolio auditors must first understand. The point to several aspects that need special attention, which inckude:

  • Difficulty in maintaining portfolio information
  • Decentralization could cause deviation from prescribed credit policy and result in fraud, error or manipulation
  • Mandate of efficiency may result in lesser controls/procedures/information/supervision
  • Burgeoning growth of portfolio could result in failures of established systems
  • Restructuring (rescheduling and refinancing) of delinquent loans is an often-used strategy to camouflage portfolio quality
  • Weak information systems may not even permit MFIs to recognize delinquency

It is noted that the audit of loan assets of an MFI’s portfolio, would include, an audit of the systems and procedures and associated lending internal controls as well. Thus, it will not only provide essential feedback with a view to safeguard the MFI’s primary asset – the loans to its members – but more importantly, it should also enable stakeholders to understand the risks inherent in the MFI’s loan portfolio and systems/ procedures used to mitigate this risk. This information could prove useful in two ways: (1) facilitate prudent decisions regarding investing in the MFI (either directly or indirectly); and more importantly, (2) help isolate specific areas for capacity building and technical assistance for enhancing the portfolio quality of the MFI.

This portfolio audit tool is structured and set out to answer the following questions:

  • How to conduct a loan portfolio audit?
  • What are the key portfolio audit procedures to be performed?
  • Is there a checklist of what to do?
  • How to audit record keeping?
  • How to review loan policies?
  • How to determine the loan sample?
  • How to document the review?
  • How to learn about the MFI’s system of internal controls over the lending activity?
  • What are the key considerations in reviewing internal controls over the lending function?, and
  • Many other (such) questions related to the loan portfolio audit in the context of microfinance.

Following the introduction, the next section outlines the basic methodology in terms of how to structure the loan portfolio audit. The third section describes the checklist and tool, which has been generated after extensive field-testing among 6 branches of 2 large MFIs and 3 branches of 2 commercial banks in South Asia/India. These checklist items correspond to the various steps given in Figure 1 in the methodology section. An Excel Rating Sheet, operationalising this check list has also been included.

The last section is the appendix which provides explanatory notes to technical aspects such as best practices format of the portfolio report and procedure for generating this report, best practices definitions and interpretations of key portfolio management indicators along with sample calculations, best practices methods for ageing of over due (past due) loans in an MFI’s portfolio, summary of key accounting process and transactions for loan portfolio management and glossary of key financial terms for loan portfolio management.

  • Resource type
  • Author Graham A.N. Wright, Ramesh S Arunachalam, Manoj Sharma and Madhurantika Moulick
  • Organisation
  • Year of Publication2006
  • Region
  • LanguageEnglish
  • Number of pages246 pp.
  • Keywords , ,

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