1. Microfinance Best Practices and Principles
NOTE TO FACILITATOR: DISTRIBUTE THE HARD COPY OF THE PPT PRESENTATION AFTER THE SESSION.

2. Session Objective
Identify the elements that comprise best practices and principles in microfinance
Explain why MF best practices and principles are important to incorporate in microfinance product design.
READ THE SLIDE.
EMPHASIZE that the practices and principles are also tools that banks can use in designing and enhancing the product they offer to their clients.

3. Main Objectives in Lending Operations
Reducing
RISK
Providing
Fast &
Quality
SERVICE
Minimizing
COST
Lending is primarily about managing your risk. However, there are two other major objectives that should be considered when designing a product or when changing or introducing new policies and procedures: these are to minimize the cost to the bank (as well as to the client) and improve the way the bank services its clients.
There are, therefore, questions you should ask when you are designing a new product or you plan to change a particular policy or procedure in an existing loan product.
Click to the next chart.

4. Assessing our Lending Policies & Procedures
When assessing whether a policy or procedure is appropriate or not, ask the following questions:
“Will the policy or procedure…..
Increase or reduce my risk of lending to this particular client?
Increase or reduce my cost of lending to this particular client?
Improve and speed up customer service?”
LET ME GIVE A CONCRETE EXAMPLE OF WHY ASKING THESE QUESTIONS ARE IMPORTANT: TAKE THE POLICY OF HAVING CLIENTS PAY DAILY AND PICKING UP THE DAILY PAYMENTS.
What is the impact of daily and pick-up collection to my cost? my customer service? And to lending risk?
Let us take customer service first: Daily pick-up collection is a service that clients value because it is convenient for them, and for some, but not all clients, they prefer paying very small loan amortizations because tiny payments are less bothersome to them.
Let us look at the risk reduction angle next: Going to the client and picking up payments daily is also considered by some banks as a way to reduce the risk of lending.
HOWEVER, THERE ARE DOWNSIDES TO DAILY PICK UP COLLECTION. It’s very costly for the bank; account officers will only be able to handle up to 60 clients; therefore, productivity in terms of number of clients and portfolio volume would be very low. This will impact in turn on the profitability of the product to the bank.
SO, IF YOUR MICROFINANCE LOAN PRODUCT STILL OFFERS DAILY PICK UP COLLECTION TO CLIENTS, consider shifting clients to weekly collection. You can also ask some of your old time good paying clients to come to the bank to pay weekly, but offer them a slightly lower interest rate to compensate for the cost they will incur and motivate them to deliver their payments to the bank.

5. Microfinance Best Practices & Principles
The practices that MFIs follow in providing financial services to low-income clients that have led to success and profit.
Best practices should be reflected from product design stage to implementation to monitoring.
What are microfinance best practices and principles?
READ BULLETS.
TO TRANSITION TO THE GROUP WORKSHOP/GAME, SAY: “We will have group workshop at this time. A set of meta cards will be distributed to each group together with an instruction sheet.”
Click to next slide.

6. GROUP EXERCISE Divide participants into 4 to 5 groups.
Each group will receive a stack of meta cards with lending practices and principles written on them.
First task is to segregate those cards that don’t belong to the elements of best practices and principles.
Each group will pick up 2 cards that don’t belong and explain why they don’t belong.
Second task is to explain the rationale behind the best practice/principle picked by the facilitator from correct answers identified by the group.
Allow 45 minutes for the exercise: 15 minutes for the group to segregate and discuss each card.
To spice up the workshop, reward those that get the correct segregation with a small bag of candies.
For further excitement, provide each group with “chocolate coins” that they can use to bet before presenting and explaining the group cards. When the explanation is incorrect, their “coins” will be taken away; when correct, there is a corresponding reward. Any of the group can challenge their explanation and offer the alternative explanation. The group that challenges should, however, place their bet first. When the challenger’s explanation is accepted (by the facilitator), the other group’s betting coin is transferred to the challenger. But when the challenger’s explanation is not accepted, the bet is taken away.

7. Microfinance Best Practices & Principles
A. Principles & Practices to Integrate in the Loan Product Design
LOAN POLICY AREA
PRACTICES &
PRINCIPLES
OBJECTIVE IN
LENDING
1. Client Selection
Clearly defined client group
Well-defined eligibility criteria for a loan product stated in a manual to standardize practice among MFU staff.
Client selection based on character assessment and repayment capacity, not collateral
Individual’s reputation in the community and the business cashflow are more important than traditional collateral.
Reduce Risk
Improve Customer Service
Reduce Cost
2. Loan Purpose
Additional working capital for existing business rather than start up business
Initial loans are generally for short-term working capital as opposed to fixed assets.
Loans for fixed asset are provided only after lending to the same client for at least one year.
Clearly defined client group
A clearly defined target market such as non-agricultural businesses with at least one year experience who have lived and worked in the community for at least 3 years is an example of a target market. Sample eligibility criteria below:
Sample Eligibility criteria
1. Micro-entrepreneurs with daily or weekly income
2. Micro-enterprise operation is at least 1 year
3. Resident of the community for at least 2 years (if
renting) and 1 year (if owns the house)
4. Can offer at least 1 Co-maker & willing to save
5. No delinquent account with the bank, or other financial
institutions, or collection case with commercial
establishments, or collection case filed with the
barangay courts
Client selection based on character assessment and repayment capacity, not collateral.
The individual’s reputation in the community and the cash flow of the business are more important than traditional collateral. Examining a potential client’s character and their repayment capacity is crucial. Proper client selection should be based on thorough credit investigation and background investigation (CI/BI) and analysis of the client’s debt capacity or cash flow.
Over-reliance on collaterals, on the other hand, can lead to improper client selection. Collaterals tend to create a false sense of security in the lender. However, foreclosed properties could fluctuate in value or be difficult to sell when the economy slows down.
Loan purpose
As much as possible, avoid lending to start-up businesses. The rate of failure among start-up businesses is high. It is believed that 9 out of 10 new businesses fail.

8. Microfinance Best Practices & Principles
LOAN POLICY AREA
PRACTICES &
PRINCIPLES
OBJECTIVE IN
LENDING
3. Loan Amount
Start loans small and increase gradually
Small initial loan mitigates lending risk to a client who does not have any bank record yet
Allows the bank time to slowly get to know the client’s “real debt” capacity and reduces the risk for the bank as well as the debt burden of the client.
Be conservative in analyzing client’s cash flow; initial loan payments should not exceed 25-35% of the client’s net income;
Loan amount can increase overtime based on successful repayment and improvements in the cashflow, but not more than 30%, as the bank gets to know the client’s business better.
Reduce Risk
Improve Service to Client by avoiding debt overburden

9. Microfinance Best Practices & Principles
LOAN POLICY AREA
PRACTICES &
PRINCIPLES
OBJECTIVE IN
LENDING
4. Loan Term
Short-term, from 3 to 6 months
Micro-enterprise operations are characterized by fast rotation of business/goods, hence, working capital has a fast turnover
3 to 6 months loan term is not too short nor too long to extend credit to a client who lacks credit history
Term of the loan can be increased gradually as the client becomes known to the bank, but look carefully at potential business risks to supplies, production and sales in giving longer loan term.
Reduce Risk
Short-term. Increase the amount and term of the loans gradually as the client becomes known to the bank.
Longer term loan may involve more risk so, carefully look at potential risks to supply, production and sales
It is also important to look at potential business risks, such as any potential risk to supplies (fish vending being dependent on good fishing; seasonal - what happens when the weather is bad and fish are scarce?); production (who operates the business when the client is sick or away? What happens when raw materials become scarce –will production decline/slow down during the time of the loan?); sales or customers (what happens when there is more competition, a new store opening up across the street, or temporary closing of the public market? Or school year ends? Or an SM Mall is established in the area?).

10. Microfinance Best Practices & Principles
LOAN POLICY AREA
PRACTICES &
PRINCIPLES
OBJECTIVE IN
LENDING
5. Frequency of Payment
Small and frequent amortization payments
Weekly for new clients; semi-monthly or monthly for mature, valued clients who have established a good repayment record
Easier for clients to pay
Frequency of payment should be balanced against the cost of collecting these payments.
Transition clients with long and good track record from weekly to semi-monthly or monthly payments.
Reduce Risk
Quality Service
Frequent and small amortization payments
The more frequent the amortizations payments, the smaller they will be, and the easier will it be for clients to pay. The frequency of payments, however, should be balanced against the costs of collecting these payments. Daily payments, for example, would have a higher cost than weekly payments

11. Microfinance Best Practices & Principles
LOAN POLICY AREA
PRACTICES &
PRINCIPLES
OBJECTIVE IN
LENDING
6. Interest Rate
Charge sufficient interest rate to cover all cost and provide good profit
Bank’s microfinance operation is a business, not a charitable service
Microfinance loans are small with frequent installment payments, hence, the transactions costs are higher than regular commercial loans.
Microenterprise clients are willing to pay higher rates for a good service.
Interest rate charged by the bank is substantially less than the 8%-10% monthly from informal lenders
Reduce Risk
Quality Service
Sufficiently high interest rates to make a good profit
Because microfinance loans are small with frequent installment payments, the transactions costs are high compared with those of regular commercial loans. The interest rate for microfinance loans, therefore, should be higher. Microenterprise clients are willing to pay higher rates for a good service.
Most rural banks with microfinance lending operation charge a monthly interest rate of 2-3% per month (amortized or non-discounted) and service charges of at least 2-3% deducted up front. The costs to the borrower are generally substantially less than the 8-10% interest per month usually charged by the 5-6ers.

12. Microfinance Best Practices & Principles
LOAN POLICY AREA
PRACTICES &
PRINCIPLES
OBJECTIVE IN
LENDING
7. Security for the Loan
Focus on Character rather than hard collateral for micro loans
Low-income households have little, or no assets
Use soft collateral or collateral substitute such as co-maker; serialized assets, stock inventory, savings hold-out
Soft collateral is secondary and only for its psychological effect on the client
Reduce Risk
Quality Service
Collateral requirements of a microfinance loans are in the form of co-makers, deposits, serialized assets, and stock inventory.

13. Microfinance Best Practices & Principles
LOAN FEATURES
PRACTICES &
PRINCIPLES
OBJECTIVE IN
LENDING
8. Savings
Client-friendly design
Low opening amount and maintaining balance; small regular deposits; deposit services are therefore accessible.
Transition mature clients with good repayment record from mandatory to voluntary savings
Reduce Risk
Quality Service
Savings:
Mandatory savings introduced as part of a loan product design is appreciated by clients, but they want access to their deposits and they should be allowed to withdraw because it is their money. Very restrictive policies on savings withdrawal is one of the reasons why clients leave the bank.
Gradually shift clients from mandatory to voluntary savings scheme.

14. Microfinance Best Practices & Principles Best Practice / Principle
B. Other Microfinance Best practices that should be observed by Institutions
Procedure/ Policy
Best Practice / Principle
Rationale
1. Bank Philosophy and Image
Provide high quality, appropriate and friendly service to micro-entrepreneurs
- Clients should feel welcome in the bank
- Rapid access
- Simple procedures
- Frequent contact with the client
Microfinance operations is a business, not a charitable service
Bank has clear objectives for its microfinance operation
Quality Service
Viability and sustainability of operations
Bank is not an NGO, you are using the depositors’ money and you need to protect their money.

15. Microfinance Best Practices & Principles Best Practice / Principle
B. Other Microfinance Best practices that should be observed by Institutions
Procedure/ Policy
Best Practice / Principle
Rationale
2. Loan Disbursement
and Monitoring
Decentralize loan approval at the branch-level credit committee
Account officers are responsible for loans they have recommended for approval
Clearly defined geographic areas assigned to account officers to avoid overlaps and competition for clients among AOs.
Frequent contact with clients
Closely monitor delinquent accounts and apply measures as indicated in the delinquency alarm signals
Reduce Cost
Quality Service
Disbursement:
Decentralized loan approval.
- Microentrepreneurs are used to the fast service they get from informal lenders. While rural banks cannot match the speed by which informal lenders extend loans to microentrepreneurs, they should ensure that new loans do not take a week or two to be processed and disbursed, while repeat loans should not take more than 24 to 48 hours.
-Involve the MFU staff in the loan approval process. Successful MFIs decentralize their loan approval in their branches through a branch-level credit committee made up of AOs and their supervisor, instead of the branch manager alone. Additional information about the loan applicant can be provided by other members of the microfinance unit and made known to the branch manager, if they are involved in evaluating the loan applications. Decentralization, however, must be implemented with adequate internal control.
Monitoring:
Account officers’ responsibility for loans
The disbursement and monitoring approach followed by successful financial institutions providing small loans make their account officers responsible for recommending and approving loans. Here, the account officers perform the following functions: conduct the CI, recommend the loan, and do loan follow-up, including collection. This level of accountability reduces the risk of late payment. AOs become more careful in recommending loans for approval if they know that they will be made directly responsible for collection, if any of the loans they have recommended become delinquent.
However, there is a caveat here. Because of the non-separation of responsibilities through collection, it is important that the bank policies and procedures are well defined and standardized with internal control strongly built in. Here, too, having a functioning management information system that can track and report loans daily is most essential.
Clearly defined geographic areas assigned to account officers
-This is to improve follow-up and efficiency of MFU staff, and avoid overlapping and grabbing of clients among staff.
Frequent contact with clients
-Due to the non-collateralized nature of microfinance loans, it is important that the account officers are able to monitor what is happening to the client’s business and household conditions. Account officers should be able to keep track of changes that they observe on their clients, especially the negative ones that could impact on their loans. Regular contact also strengthens the bank-client relationship.
Delinquency alarm signals are consistently followed
-Having delinquency alarm signals is a basic ingredient of the ZERO TOLERANCE culture and practices successful banks observe. “Alarm signals” are used to follow-up and increase pressure on problem clients. These include immediate follow-up the day a payment is missed or at least the following morning, also, follow-up visits by the supervisor and manager when payments are missed by 3 days and 7 days, respectively

16. Microfinance Best Practices & Principles Best Practice / Principle
B. Other Microfinance Best practices that should be observed by Institutions
Procedure/ Policy
Best Practice / Principle
Rationale
3. Zero Tolerance against Delinquency
Loans with payments delayed by just one (1) day are considered delinquent, and bank staff takes step immediately to collect.
Portfolio at Risk (PAR), not past due, define portfolio quality
Pursue delinquent clients, whatever the cost, to establish and maintain zero tolerance
The culture of zero tolerance, or strict credit discipline, should start with top management and communicated to the staff and clients
“DELINQUENCY ALARM SIGNALS” are consistently followed
Reduce risk
Minimize cost
Delinquency alarm signals are consistently followed
-Having delinquency alarm signals is a basic ingredient of the ZERO TOLERANCE culture and practices successful banks observe. “Alarm signals” are used to follow-up and increase pressure on problem clients. These include immediate follow-up the day a payment is missed or at least the following morning, also, follow-up visits by the supervisor and manager when payments are missed by 3 days and 7 days, respectively

17. Microfinance Best Practices & Principles Best Practice / Principle
B. Other Microfinance Best practices that should be observed by Institutions
Procedure/ Policy
Best Practice / Principle
Rationale
4. Management Information System (MIS)
Automated MIS is key to tracking the performance of the microfinance portfolio
MIS reports are tools for monitoring by top and middle level management & supervisors
At a minimum, should be able to track missed payments, account officers responsible for their collection, and portfolio at risk with aging
MIS report should show the performance of each account officer
Reduce risk
MIS reports must be utilized by the Account Officers and they must know what reports to use. Managers and Supervisors should regularly look at these reports, if not daily, on weekly basis.

18. Microfinance Best Practices & Principles Best Practice / Principle
B. Other Microfinance Best practices that should be observed by Institutions
Procedure/ Policy
Best Practice / Principle
Rationale
5. Loan Loss
Provisioning
Adequate provisioning is a sound banking practice to cushion probable losses
Provide loan loss provision based on BSP requirements (BSP Circular 409)
Current Loans %
1 – 30 days %
31 – 60 days/restructured once %
61 – 90 days %
More than 90 days/
restructured twice %
Promote good portfolio quality
LLP is mandated by the Bangko Sentral ng Pilipinas. BSP is looking at how banks are setting aside for loans, current and those that are at risks. Those bad loans that are fully provisioned and are deemed uncollectible must already be written off.

19. Microfinance Best Practices & Principles Best Practice / Principle
B. Other Microfinance Best practices that should be observed by Institutions
Procedure/ Policy
Best Practice / Principle
Rationale
6. Internal Control
Pick-up collection of loan payments (a valued service demanded by microfinance clients) could lead to internal control problems
Bank should be able to track missed payments through MIS
MFU Supervisor should verify cases of delayed/non-payment of installments immediately when they occur
Other checkpoints:
- Loan review & approval by Credit Committee
- Regular random check of clients by MFU
Supervisor or audit personnel
Reduce risks

20. Keys to Success in Microfinance
 Strong institutional commitment
 Demand-oriented loan and savings products
 Good client service
 Good client selection process
 Sufficient interest rates to cover costs
 Zero tolerance against delinquency
 Good MIS
 Adequate loan-loss provisioning
 Adequate internal control measures