Steps to manage microfinance business

Default in Microfinance business

The industry for micro finance is shrinking due to high delinquency, where instalments are overdue by 30 to 180 days, jumped to 4.3% in 2024 vs 2% in 2023. Microfinance portfolio is worth 4.1 lac crore in 2024.

Concerns are due to multiple loans availed by cm. (generally 3 or more).

There has to be robust financial practices and strengthen their viability to serve rural customers better.

Few States like Bihar, Tamil Nadu, UP and Odisha account for 62% of the incremental delinquencies.

Steps to manage it better :

1. Robust Credit Assessment Process

• Thorough Risk Assessment: Implement a comprehensive risk profiling of clients. This should consider both financial and non-financial factors (e.g., employment status, family support, community ties, and asset ownership).
• Credit Scoring Models: Use credit scoring models tailored for microfinance clients, incorporating alternative data sources, such as payment history, social behavior, and community engagement.

2. Loan Size and Terms Customization

• Flexible Loan Amounts: Customize loan amounts based on the client’s repayment capacity rather than a one-size-fits-all approach.
• Gradual Loan Scaling: Implement progressive lending, where clients start with smaller loans and can borrow larger amounts only after successfully repaying earlier loans.
• Loan Term Flexibility: Offer flexible loan terms that align with the borrower’s income cycle. For instance, agriculture-based borrowers may have seasonal repayment schedules, whereas urban-based businesses may have monthly terms.

3. Group Lending and Peer Pressure

• Group Lending Model: Many microfinance institutions (MFIs) use group lending, where a small group of borrowers collectively guarantees the repayment of each other’s loans. This creates a social pressure for timely repayments.
• Social Collateral: Clients in group lending models are responsible for each other's repayment, and this shared liability can encourage members to make sure no one defaults.
• Community Engagement: Encourage social accountability by fostering strong relationships within communities.

4. Pre-Disbursement and Post-Disbursement Monitoring

• Pre-Disbursement Verification: Before granting loans, visit the borrowers' businesses or homes to verify the need and the capability to repay.
• Regular Monitoring: Track the usage of funds and business performance periodically. Make sure the loan is being used for the intended purpose, which increases the likelihood of repayment.
• Installment Reminders: Send regular reminders to borrowers about upcoming payments via text, calls, or through agents.

5. Insurance Products and Risk Mitigation

• Credit Life Insurance: Offer insurance products that protect borrowers and lenders from unforeseen circumstances like death, illness, or accidents.
• Income Protection: Some microfinance institutions offer income protection plans for borrowers in case of job loss or other financial distress.
• Weather Insurance for Agriculture: In rural areas, weather-related insurance products can safeguard agriculture-based loans against crop failure.

6.Incentivizing Timely Repayment

• Rewards for Good Borrowers: Create loyalty programs or reward systems for borrowers who consistently repay on time. This can include lower interest rates on future loans or access to larger loan amounts.
• Penalty for Defaults: While penalties should be fair and transparent, some MFIs impose small fines or limit future loan eligibility for clients who default, making it important for borrowers to repay on time.

7. Diversification of Loan Portfolios

• Sectoral Diversification: Avoid concentration of loans in one sector (e.g., agriculture) or one region. A diversified loan portfolio reduces the risk of defaults caused by sector-specific risks such as crop failure or economic downturns in a region.
• Client Type Diversification: Along with group loans, offer individual loans to those with a higher repayment track record to balance the risk profile.

8. Technology and Data Analytics

• Automated Loan Monitoring: Implement technology-driven tools for tracking loan disbursements and repayments. This can help in detecting any early signs of distress in the borrower’s repayment behavior.
• Data-Driven Decision Making: Use data analytics to identify patterns of loan defaults and adjust lending practices accordingly. For instance, analytics can predict areas or sectors where defaults are more likely to occur, enabling preemptive action.

9. Collection Strategies

• Flexible Repayment Methods: Offer different payment channels (e.g., mobile payments, bank transfers, or agent-assisted payments) to make repayments more convenient.
• Early Intervention: If a borrower misses a payment, make contact early to understand the reason and offer assistance or a revised repayment plan.
• Legal Actions as a Last Resort: While MFIs should ideally exhaust all other options, they must also have legal frameworks in place to pursue borrowers who consistently default, to protect their business model.

10. Insurance Products and Risk Mitigation

• Credit Life Insurance: Offer insurance products that protect borrowers and lenders from unforeseen circumstances like death, illness, or accidents.
• Income Protection: Some microfinance institutions offer income protection plans for borrowers in case of job loss or other financial distress.