Credit Risk

Credit risk encompasses the risks related to an MFI’s credit activities. It is the most frequently addressed risk by MFIs since it directly affects their main earning asset: the loan portfolio. It includes the risk of financial loss resulting from the inability to collect anticipated interest earnings, or on capital resulting from loan default, as well as the negative social performance resulting from credit activities which do not have the best interest of clients in mind (e.g., a lack of transparency toward the clients, continued lending to over-indebted clients). Two subcategories have been identified within credit risk: credit transaction risk and portfolio risk.

  • Credit Transaction Risk – Credit transaction risk is the risk of financial losses and negative social performance related to loans to clients, caused by inadequate policies regarding loan disbursement, follow-up, and recovery.
  • Portfolio Risk – Portfolio risk is the risk of financial losses and negative social performance related to the composition of the overall loan portfolio, caused by inadequate portfolio diversification.

Credit Transaction Risk

Policies

Tier 3 Guidelines
Tier 2 Guidelines
Tier 1 Guidelines
Formal set of credit policies and procedures to manage credit risk, including those covering: Formal set of credit policies and procedures to manage credit risk, including those covering: Formal set of credit policies and procedures to manage credit risk, including those covering:
• Credit process • Credit process • Credit process
• Identity checking / know your client (e.g., visit to client’s business) • Identity checking / know your client (e.g., visit to client’s business) • Identity checking / know your client (e.g., visit to client’s business)
• Data verification • Data verification • Data verification
• Products, services, and their characteristics • Products, services, and their characteristics • Products, services, and their characteristics
• Use of credit bureau information • Use of credit bureau information • Use of credit bureau information
• Parallel loans with other institutions • Parallel loans with other institutions • Parallel loans with other institutions
• Internal parallel loans • Internal parallel loans • Internal parallel loans
• Repayment capacity and overindebtedness prevention • Repayment capacity and overindebtedness prevention • Repayment capacity and overindebtedness prevention
• Required guarantees and their valuation • Required guarantees and their valuation • Required guarantees and their valuation
• Loan monitoring, recovery, and collection • Loan monitoring, recovery, and collection • Loan monitoring, recovery, and collection
• Related-party loans • Related-party loans • Related-party loans
• Loan restructuring • Loan restructuring • Loan restructuring
• Loan provisioning • Loan provisioning • Loan provisioning
• Write-offs • Write-offs • Write-offs
• Non-permitted lending activities • Non-permitted lending activities • Non-permitted lending activities
• Credit approval levels • Credit approval committees • Credit approval committees
• Code of ethical conduct • Code of ethical conduct • Code of ethical conduct
• Credit policies in line with SMART Campaign guidelines • Credit policies in line with SMART Campaign guidelines • Credit policies in line with SMART Campaign guidelines

Limits

Tier 3 Guidelines
Tier 2 Guidelines
Tier 1 Guidelines
Portfolio quality Portfolio quality Portfolio quality
• Limit on PAR30 • Limit on PAR by aging structure • Limit on PAR by aging structure
• Limit on restructured portfolio • Limit on restructured portfolio • Limit on restructured portfolio by aging structure
• Limit on write-offs • Limit on write-offs • Limit on write-offs
Provisions Provisions Provisions
• Limit on provisions over PAR30 • Limit on provisions over PAR30 • Limit on provisions over PAR30
• Limit by loan risk category • Limit by loan risk category • Limit by loan risk category
Limit on related-party loans Limit on related-party loans

Risk Management Tools

Tier 3 Guidelines
Tier 2 Guidelines
Tier 1 Guidelines
Standardized application of credit policies and procedures Standardized application of credit policies and procedures Standardized application of credit policies and procedures
Good and updated knowledge of the client’s main sectors Good and updated knowledge of the client’s main sectors Good and updated knowledge of the client’s main sectors
Systematic consultation of main credit bureau Systematic consultation of main credit bureau Systematic consultation of most credit bureaus
Tool for the calculation of repayment capacity by product Tool for the calculation of repayment capacity by product Tool for the calculation of repayment capacity by product
Systematic visit to client’s home and business Systematic visit to client’s and guarantor’s home and business Systematic visit to client’s and guarantor’s home and business
Professional and well-functioning central credit committee Professional and well-functioning central and local credit committees with good feedback mechanism to loan officers Professional and well-functioning central and local credit committees with independent opinions regarding exceptions and good feedback mechanism to loan officers
Tool for the monthly provisioning of loans Tool for the monthly provisioning of loans based on classification by risk category Automatic provisioning of loans based on automatic classification by risk category
Tool for the evaluation of guarantees Independent entity or person for the evaluation of guarantees
Approval of restructured loans by different committee from the committee which approved the underlying loan Approval of restructured loans by different committee from the committee which approved the underlying loan
Incentive system for field personnel in line with financial and social objectives Incentive system for field personnel in line with financial and social objectives
Statistical credit scoring model for loan analysis
Existence of dedicated recovery or collection department

Risk Monitoring Tools

Tier 3 Guidelines
Tier 2 Guidelines
Tier 1 Guidelines
Mapping of credit transaction risks (at least every two years) Mapping of credit transaction risks (at least every two years) Annual mapping of credit transaction risks
Weekly arrears reports for field personnel Daily arrears reports for field personnel Automatic daily arrears reports for field personnel
Monthly report containing main credit risk indicators, including: Monthly report containing main credit risk indicators, including: Monthly report containing main credit risk indicators, including:
• PAR30 • PAR by ageing structure • PAR by ageing structure
• Restructured portfolio • Restructured portfolio • Restructured portfolio by ageing structure
• Write-offs • Write-offs • Write-offs
• Trend analysis • Trend analysis • Trend analysis
• Compared to limits • Compared to limits • Compared to limits
Monthly monitoring of provisions, including: Monthly monitoring of provisions, including: Monthly monitoring of provisions, including:
• Provisions over PAR30 • Provisions over PAR30 • Provisions over PAR30
• Provisions by risk category • Provisions by risk category • Provisions by risk category
• Trend analysis • Trend analysis • Trend analysis
• Compared to limits • Compared to limits • Compared to limits
• Provision expense ratio • Provision expense ratio
Quarterly report of related-party loans Monthly report of related-party loans Automatic monthly report of related-party loans
Annual shared clients or client overindebtedness report Shared clients or client overindebtedness report at least twice a year
Monthly monitoring of statistical credit scoring reports
Vintage analysis
Portfolio transition analysis

Portfolio Risk

Policies

Tier 3 Guidelines
Tier 2 Guidelines
Tier 1 Guidelines
Formal set of portfolio diversification policies and procedures Formal set of portfolio diversification policies and procedures

Limits

Tier 3 Guidelines
Tier 2 Guidelines
Tier 1 Guidelines
Maximum loan amount for each credit product Maximum loan amount for each credit product Maximum loan amount for each credit product
Portfolio concentration limits by: Portfolio concentration limits by: Portfolio concentration limits by:
• Product • Product • Product
• Branch • Branch • Branch
• Economic sector • Economic sector
• Credit methodology
• Region
PAR limits by: PAR limits by: PAR limits by:
• Product • Product • Product
• Branch • Branch • Branch
• Economic sector • Economic sector
• Credit methodology
• Region

Risk Management Tools

Tier 3 Guidelines
Tier 2 Guidelines
Tier 1 Guidelines
Annual analysis of geographical areas Quarterly analysis of geographical areas
Annual analysis of economic sectors Quarterly analysis of economic sectors

Risk Monitoring Tools

Tier 3 Guidelines
Tier 2 Guidelines
Tier 1 Guidelines
Mapping of portfolio risks (at least every two years) Mapping of portfolio risks (at least every two years) Annual mapping of portfolio risks
Weekly portfolio concentration reports, including those organized by: Weekly portfolio concentration reports, including those organized by: Weekly portfolio concentration reports, including those organized by:
• Trend analysis • Trend analysis • Trend analysis
• Limits comparison • Limits comparison • Limits comparison
• By product • By product • By product
• By branch • By branch • By branch
• By economic sector • By economic sector
• By credit methodology
• By region
Weekly PAR reports, organized by: Weekly PAR reports, organized by: Weekly PAR reports, organized by:
• Trend analysis • Trend analysis • Trend analysis
• Limits comparison • Limits comparison • Limits comparison
• Product • Product • Product
• Branch • Branch • Branch
• Economic sector • Economic sector
• Credit methodology
• Region

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RIM’s Risk Management Graduation Model is continually being revised to reflect the consensus standards within the microfinance industry.

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