80913 MAY 2013 ABOUT THE AUTHORS MATT LEONARD Managing Credit Risk in Microfinance: is an Associate Operations Officer who has been with IFC’s Cairo office for two years. He is a Challenges in the Wake of the Arab Spring core team member of Access to Finance Advisory Services in MENA and currently manages a Enda Inter-Arabe (ENDA), a market-leading microfinance institution portfolio of microfinance projects with leading institutions in the (MFI) in Tunisia, was one of the first MFIs affected by a repayment crisis region. He brings over 12 years of experience in inclusive linked to the so-called Arab Spring. However, rather than spiral out of finance, livelihoods, and social development. control, ENDA took quick steps to limit the damage while demonstrating an unwavering commitment to its clients. Today, IFC is helping ENDA APPROVING MANAGERS Hicham Bayali, Microfinance remain at the vanguard of regional MFIs through the adoption of Program Manager, and Xavier Reille, Regional Business Line Leader, advanced risk-management practices. This SmartLesson highlights the Access to Finance Advisory, MENA. lessons learned from the crisis, explores the nuances of effective credit- risk management, and shows how MFIs like ENDA can remain ahead of the curve in the years to come. Background Box 1: ENDA Inter-Arabe Tunisia, where a micro-entrepreneur’s self- Founded in 1990 as part of the international immolation in December 2010 set off the ENDA Third World network, ENDA Inter- chain of events now known as the Arab Arabe (ENDA) has risen to become one of Spring, was at the forefront of a wave of the largest and most successful MFIs in the revolutions in the region that brought Arab World. In 2003, it became the first, and both promise (the evolution toward more only, sustainable MFI in Tunisia. In 2011, it democratic governance) and distress (socio- achieved full autonomy when it registered economic disruptions). as a local NGO. ENDA offers an array of credit products as well as non-credit business Despite the conventional wisdom that development support and training aimed microfinance is countercyclical and typically at primarily low-income households and more resilient in the face of macro-level female micro-entrepreneurs. By March 2013, shocks, the country’s microfinance sector ENDA had over 218,000 active clients, 68% of (the MENA region’s third largest, with them women, and an active loan portfolio of between 300,000 and 400,000 borrowers1) US$87 million. was affected by the economic malaise that followed the revolution. With Tunisia’s ENDA, which had always enjoyed exceptional economy in crisis, its leading MFI, ENDA portfolio quality, saw its Portfolio at Risk Inter-Arabe (ENDA), began to accumulate as of 30 Days (PAR>30) rise from 0.3% in loan delinquencies across its portfolio. December 2010 to over 6% by October 2011. During the revolution, ENDA had to IFC is currently providing ENDA with an temporarily close some branches, and investment and advisory-services package many of its micro-credit clients were deeply focused on building capacity in key areas, affected by the contraction of the economy. including nonperforming loans and risk For example, small entrepreneurs near the management. This support has been timely. Libyan border were unable to continue cross-frontier trade (commerce à valise), 1 Ministre de Finance de Tunisie “Vision Concertée while much of the wider population faced pour le Développement de la Microfinance,� 2011 SMARTLESSONS — MAY 2013 1 slowed its expansion and adjusted its incentive system to emphasize portfolio quality over volume. However, it did not turn away from those clients that were most in need. It continued to serve agri-entrepreneurs in at-risk rural areas, opened new branches in the south of the country, and even provided specialized services targeting refugees and returnees from Libya. ENDA’s financial partners (including IFC) likewise stood by it and continued to make available new loan facilities and support. By 2012, as its portfolio began to stabilize and improve, it even began piloting a start-up loan product for youth entrepreneurs (Bidaya) as well as exploring new Figure 1. ENDA Key Trends (2010 - 2013). channels (mobile banking) as a way to serve clients more efficiently and cost-effectively. difficulty as inflation rose, revenues from tourism and Lesson 2: Develop a tailored recovery strategy. other key sectors declined, and households refrained from spending. A deliberate, well-tailored recovery strategy is a critical element of any effective response to rising repayment Like many MFIs, ENDA finances the majority of its issues. ENDA quickly put in place a dedicated recovery credit portfolio through repayments, and thus rising team, organized high-profile campaigns to collect overdue delinquencies–when coupled with a lack of new loan amounts, and even instructed some of its call-center disbursements–presented not only a credit risk but agents to follow up with delinquent clients by telephone. operational and liquidity risks as well. Fortunately, the It also segmented its past-due loan portfolio, based on people, processes, and systems that ENDA had nurtured and conversations with clients, into different categories, such put in place over many years proved resilient. Furthermore, as willful default as opposed to default due to economic before the dust had fully settled, ENDA began working hardship. This allowed the staff to better target its efforts, with IFC to proactively implement new measures to including negotiation of new terms and/or collection of enhance its risk management—particularly in credit and partial payments from clients. Later, with the support operational risk, which historically are the most serious risk of IFC, ENDA further tailored its recovery strategy to: areas affecting MFIs—to minimize the likelihood of such a differentiate loan officers following up on loans less than situation recurring, and if it did, to mitigate its severity. 90 days overdue from recovery agents focused on loans more than 90 days late; categorize clients by relative Lesson 1: Stand by your clients, and they will stand by likelihood to repay; highlight more at-risk segments of you.2 overdue loans; and understand the effect on provisioning. To assure success, these efforts were well documented and As a mission-driven organization that was determined integrated into ENDA’s management information system to help its clientele in a time of difficulty, ENDA did not (MIS) to enable effective monitoring and appropriate merely adopt a reactive approach to rising delinquencies follow-up by recovery agents or supervisors. by panicking, turning off the faucet on new loans, and focusing entirely on repayment. Instead, it remained Lesson 3: Nurture strong relationships with your staff. true to two tenets of (micro-) banking orthodoxy: know your client (KYC) and relationships matter. The staff held Often overlooked in a crisis is the importance of the meetings with clients in all branches to better understand relationship between an MFI and its staff, and consequently their problems and how best to support them. its staff and clients. ENDA employs over 1,000 staff spread across more than 65 branches. After the revolution, many The outcome of these meetings included the development employers in Tunisia began to face more confrontational of a new “disaster� loan product, which was made available attitudes from their employees, which challenged work to distressed clients at a subsidized rate, and the selective environments and also led to higher turnover rates. use of rescheduling and repayment grace periods. ENDA While ENDA likewise experienced this change, the strong also went on the radio and television to distance itself organizational culture it had built over the years assured from the former regime and reiterate its commitment to it the support and loyalty of its long-time staff, many of the poor. Taken together, these steps helped assuage the concerns of both clients and the broader public. “When the revolution started, in many cases, our clients This is not to say that ENDA continued, in the aftermath protected the ENDA branch from potential looters.� of the crisis, to grow apace as it had before. Rather, it Essma Ben Hamida, Co-founder and Executive Director, 2 Michael Cracknell, Measures to overcome Revolution-Induced ENDA. Problems, http://www.cgap.org/blog/measures-overcome-revolution- induced-problems 2 SMARTLESSONS — MAY 2013 whom protected branches or volunteered to assist clients in affected areas. However, ENDA’s management also needed to take quick and decisive action with regard to its personnel. For example, it adjusted salaries to ensure employees had a stable income to offset the lower incentives that ensued from declining loan volumes. It also gave branches and staff new autonomy to resolve issues in the field, and used IFC assistance to invest in additional training on recovery strategies. And rather than give its more experienced staff the difficult task of recovering overdue loans (which was often viewed negatively), ENDA wisely shifted younger and more recently hired field employees into these roles. As Figure 3. ENDA vintage curve analysis (2010-2011). ENDA fielded this new team of dedicated recovery agents (RAs), it became necessary to weigh cost against benefit. automated anomaly-detection system that could be linked Indeed, when RAs began collecting smaller amounts than to the MIS. The system uses a linear-regression model that expected, ENDA reduced the fixed amount it paid RAs and detects discrepancies between financial analyses of a client increased the incentive-based portion of their monthly (for example, summaries of business revenue and income, salaries, leading to better results. Despite challenges, household income and expenses) and the loan amount ENDA’s swift human-resource interventions yielded requested; any anomaly will automatically trigger further significant dividends, including keeping staff morale high analysis. Finally, to reinforce solid credit-underwriting and improving recovery of overdue loans. decisions, the institution began deploying credit analysts who helped further develop a risk culture by scrutinizing Lesson 4: Go back to basics: reinforce credit specific applications. underwriting. Lesson 5: Harness data to create an early-warning While much of ENDA’s delinquency was linked to the system… revolution, coupled with Tunisia’s subsequent economic slowdown and the closing of border with Libya, a close Relying on the portfolio-at-risk metric, a conventional analysis of field activity revealed that staff often deviated but lagging indicator of microfinance portfolio quality, from its standard loan appraisal and approval process. merely permits the assessment of risk events “after the For example, loan officers often focused their analyses fact.� Instead, IFC helped ENDA adopt and integrate new exclusively on a client’s business and failed to factor total tools into its monthly reporting system to monitor the household income and expenses in calculating loan size or accumulation of credit risk before a repayment problem a client’s ability to make monthly payments. Furthermore, involving a few clients becomes a portfolio issue. These it was clear that adherence to credit policy varied from include vintage curves, which graphically represent default branch to branch and region to region. in a given set of loans over time, allowing disbursements to be further segmented by region, product or business To address these challenges, IFC supported additional unit. ENDA also has adopted the use of transition matrices training and implementation of oversight mechanisms which monitor arrears in a tabular format by predicting in the field to improve and standardize the loan-making the likelihood of deterioration or improvement in a given and review processes. In addition, it helped ENDA build an category of arrears (30-day, 90-day). Tools of this sort, which constitute leading indicators, can be used for more accurate loan-portfolio provisioning as well as to guide or monitor the effectiveness of collection and recovery strategies, and thus allow MFIs like ENDA to take proactive risk-mitigation measures in a timely fashion. Lesson 6: …and a predictive credit-scoring model. Beyond simply measuring and monitoring risk, effective risk management should help avoid or at least mitigate the key risks facing an organization. In the case of financial institutions, credit risk is usually of primary importance. Given its already extensive database of client information, ENDA was well placed to develop a credit-scoring tool that would help it analyze and approve loans with greater Figure 2.A jewelry entrepreneur and ENDA Client (IFC). sophistication and ultimately reduce losses from avoidable loan defaults. SMARTLESSONS — MAY 2013 3 By mid-2012, with IFC support, a credit- getting pulled into battles with operations risk expert helped ENDA design an staff, whose commercially driven goals are initial scoring model that used predictive at odds with their own. However, credit statistical methods to analyze the behavior analysts do the opposite: they frequently of previous customers and make predictions curb unfettered growth and bedevil staff on the relative credit risk of new clients and managers who have portfolio targets (e.g., likelihood of default). It was prudent linked to incentives. Still, these conundrums to pilot such a tool offline for up to a year are not unusual; each MFI must find its way, to allow for testing and adjustments to the taking into consideration sound practice, its model. Thus far, the pilot-test has shown own unique character, and risk tolerance. strong results, and the tool demonstrates strong predictive ability. ENDA is currently Conclusion training its staff in the implementation of the credit scoring tool, and hopes to roll it out Today, Tunisia and the wider region formally by the summer of 2013. However, continue to suffer from political and social credit scoring should neither replace nor tension, rising unemployment, and slower undermine the qualitative research typically economic growth, all of which present an undertaken by loan officers in the field, nor elevated risk environment for MFIs. This should it substitute for sound underwriting is particularly relevant to the sector as the practices, adequate financial analysis, or country’s regulatory body for microfinance strong customer relationships. prepares to enact new legislation that may transform the sector by allowing for new Lesson 7: An independent view -- credit commercial entrants. analysts under a risk-management unit. With the support of IFC, ENDA has absorbed Taking a page from the playbook of banks the lessons of the crisis and relatively and advanced MFIs (such as those in the Latin quickly returned to sustainable growth America and Caribbean region), ENDA took and strong portfolio quality while setting the difficult step of placing an independent high standards among MFIs in the region in check on its lending and commercial the management and handling of risk. Its activity: the creation of a credit analyst success is critical: estimates put the number position. In principle, a credit analyst’s role of micro-entrepreneurs still with limited is straightforward: to focus exclusively on or no access to finance in Tunisia at 1.2-1.4 portfolio quality by assisting with ongoing million (nearly 12% of the population). credit scoring; to further analyze loans that meet certain risk criteria; and to assess In fact, as part of its regional strategy, IFC incidents and/or default patterns. is now providing risk-management advisory support to other MFIs to help them adopt However, implementation has been and integrate advanced risk-management challenging, and ENDA continues to face tools and systems into their operations, a number of key questions. One of these measure and mitigate risks, and continue to is how to select the right candidates. Thus expand outreach to low-income households far it has begun using high-performing loan in a more sustainable manner. Given its officers who have aspirations for greater achievements, Tunisia and ENDA are well DISCLAIMER responsibility and who view the role of placed to remain at the forefront of MFI SmartLessons is an awards credit analyst as a step forward career- developments in the MENA region. program to share lessons learned wise. A second important consideration in development-oriented advisory services and investment is how many credit analysts are sufficient operations. The findings, vis-à-vis the portfolio or staffing size, and interpretations, and conclusions how to quantify their contributions vis- expressed in this paper are those of the author(s) and do not à-vis the costs they incur. Furthermore, necessarily reflect the views of should credit analysts be based in the field IFC or its partner organizations, or at headquarters? How should they be the Executive Directors of The deployed? To whom should they report? World Bank or the governments they represent. IFC does not assume any responsibility for the Risk-management units typically do not completeness or accuracy of the insert themselves into the daily business information contained in this document. Please see the terms of MFIs. They should ideally retain an and conditions at www.ifc.org/ independent outlook and focus on making smartlessons or contact the recommendations about risk rather than program at smartlessons@ifc.org. 4 SMARTLESSONS — MAY 2013