Evolution of Standards in Financial Analysis for Microfinance:

1
Evolution of Standards in Financial Analysis for
Microfinance

• An Overview of 20 years of history in 20 minutes

Presented at SEEP Annual Meeting, October
2003 Chuck Waterfield waterfield_at_microfin.com
2
Overview

• Brief historical overview
• History of the FSWG Financial Ratios paper
• Evolution of selected key ratios
• Opinions on progress and directions

3
Financial ratios in the 1980's

• Ratio? What's a ratio?
• Whatever ratios existed at the time were
  primarily adaptations of general development
  projects. For example
• Number of beneficiaries assisted since project
  inception
• Often times multiplying the number of "clients"
  by 5 to include all family members
• Dollars loaned since project inception
• With the common 4-month loan terms, a 100,000
  portfolio could be reported as 600,000 in loans
  every year
• Repayment rate
• Lots of odd measures, like Amount Paid this
  month / Amount Due
• No standardization at all

4
1990-95 The Emergence of Standards

• Beginning of some serious approaches
• NGO people start reading banking textbooks
• ACCION publications
• Financial Management Guidebook for NGOs, Bob
  Christen 1990
• Delinquency The Hidden Beast, Kathy Stearns,
  1991
• GEMINI Publications
• Static Viability model, 1992
• Margaret Bartel series on Financial Ratios, 1995
• SEEP FSWG Financial Ratios Paper, 1995

5
1995-2000The Acceptance of Standards

• NGOs started recruiting Bankers
• Get used to hearing Why do you do that? That
  doesn't make any sense.
• Full emergence of banking ratios
• 1996 Boulder MFT Curriculum
• 1997 Microbanking Bulletin
• 1997 CGAP MIS and Appraisal Format
• 1998 Microfin
• Everyone now supports sustainability

6
2000's

• Reaching consensus, debating the nuances
• The most difficult battles are over
• Fine-tuning the financial adjustments
• How to handle taxes?
• Increased role of savings in MFIs

7
Why is this so complicated?

• Devil is in the details
• Chart of Accounts
• Accounting Procedures
• Portfolio Management Policies (reserve
  write-off)
• MIS determines what information we have available

8
SEEP Financial Ratios PaperBirth of the idea

• SEEP AGM in October 1994
• total attendance of 40-50 people
• SEEP had one half-time staffperson
• Who was involved
• Jim Cawley, NCBA
• Elaine Edgcomb, SEEP
• Mark King Kerry Moloney, Opportunity
• Mark Flaming, MEDA
• Graham Perrett, FFH
• Tony Sheldon, WWB
• Alain Plouffe, Socodevi
• Bill Tucker, WOCCU
• Joanna Ledgerwood, Calmeadow
• Chuck Waterfield, CARE

9
The Idea Debated

• Jim Cawley originally proposed the idea
• Me Although interesting, it will be impossible
  for us to get everyone to agree. We need to pick
  a more realistic project to work on.
• Jim Either we do this to ourselves or it will
  be done to us.
• Fortunately, Jim won the debate.

10
We included this caveat

• It is conceivable that financial ratios could
  be used for cross-program comparison.This would
  be a dangerous misuse of financial ratios. Any
  attempt at comparison of one institution with
  another must be done in full awareness of the
  significant contextual and methodological factors
  that affect these ratios.
• What is possible becomes inevitable there is no
  way we could have avoided this by ignoring it, so
  we addressed it head on.

11
Contributions of Paper

• Easily understood by inexperienced managers
• First consensus set of standard indicators
• Presented standard financial statements
• Cost structure analysis (see graph)

12
Does the Original Paper need Revision?

• Yes
• It was written 9 years ago.
• Clearly the industry has changed and matured
• Savings is much more important now
• Financing sources are much more complex and
  diversified than before
• But dont lose sight of what made the first
  paper successful!

13
Ratio Categories

• The SEEP paper presented 16 ratios divided into
  three groups
• Sustainability
• Efficiency/Productivity
• Portfolio Quality
• Will look at these three categories

14
Phase ISustainability as Cost Recovery

• First considered as a "cost recovery
• Goal was to get to 100
• My four levels in GEMINI Static Viability Paper
• Level 1 Income covers operating expenses
• Level 2 Add Cost of Capital
• Level 3 Add Loan loss Provisions
• Level 4 Add impact of inflation on equity
• ACCION compressed to three levels

15
Phase IISustainability as Profitability

• Hurdle gets raised with more focus on financial
  adjustments
• Jacob Yaron's "Subsidy Dependency Index
• 2 levelsOperational / Financial Sustainability
• New adjustments, e.g. in-kind subsidies
• Shift from cost-recovery to profitability
• ROA/ROE and AROA/AROE

16
Sustainability vs. Efficiency

• We obsess about sustainability, but have a
  limited understanding of efficiency and its role
  in sustainability
• We applaud MFIs that achieve financial
  sustainability generally without analysis of
  their effective interest rate or their
  operational efficiencies

17
Efficiency Indicators

• Started with a poor selection
• Cost per dollar loaned
• USAID definition of Operational Efficiency in
  1995 ("Maximizing Outreach")
• This is the ability of a program to cover all
  non-financial expenses out of program fees and
  interest charges.
• In other words, Let's raise our interest rate so
  we can become more efficient
• BancoSol presentation last month used this same
  definition
• Cost structure approach an improvement
• We need to give more emphasis to this area

18
Portfolio Quality

• In the '80's hardly anybody did reserves or
  write-offs
• The Hidden Beast, 1990, changed the world
• 20 different formulas for measuring portfolio
  quality
• Advocated use of Portfolio at Risk
• As portfolio size grew, we adopted more rigorous
  treatment of provisioning, aging, reserves, and
  write-off
• Regulation has helped a lot in promoting
  consistency
• Agreement that aging should be based on the
  maturity and risk of the product
• Agreement that loan loss reserves should be set
  aside and loans written off regularly

19
Have we made progress?

• Clearly, Yes.
• The ratios make more sense
• There is much more agreement on definitions
• probably 90-95 of the way there
• But... we risk focusing only on business ratios
• the majority of the ratios look just like bank
  ratios
• in fact we may be more bank-like than banks
• current approaches emphasize single bottom line
  profitability
• we started with social mandates
• danger of shifting all the way to business
  mandatesbypassing the "social business"
  middle-ground

20
A need for Service Indicators

• SEEP FSWG is discussing adding in this new
  category
• Average loan size
• Client retention rates
• Staff turnover rates, etc
• Should these be separate?
• No. They will get overlooked, granted minority
  status
• Should they be extensive?
• No. Keep them simple and limited. Still a need
  for separate in-depth impact and socioeconomic
  analysis tools.
• Does it still count as financial analysis?
• Yes. Some inclusion in tools like Microbanking
  Bulletin

21
In Conclusion

• Great progress over the past 10 years in
  standards
• Combined with strong focus on training in these
  standards
• Occasional strenuous debate resulting in an
  emerging consensus
• But lets not lose sight of why we are working in
  this field in the first place. Financial
  indicators can help keep us true to our mission.