What Every Good Microfinance Business Should Track and Why

A client officer of AMZ collects loan repayments. (Photo courtesy of Agora Microfinance Zambia)

If there were a version of the Olympics that recognized star players in the advancement of international development, microfinance—banking services for low-income people who would otherwise lack access to financial services—would deserve a gold medal. When it comes to defining indicators, establishing best practices, and creating ratings and certifications, no other industry has been as dedicated to producing ways to measure, assess, and monitor social performance management—all of which enables institutions to align their operations with their social missions.

Yet, despite the wealth of knowledge available, many microfinance impact investors are not monitoring the social components of the financial service providers (FSPs) they finance. Its not that the sector hasn’t made progress—a number of these impact investors have already effectively integrated social assessment into their due diligence and even agreed to adopt a common audit tool, the SPI4, to track the most relevant social performance indicators. But the impact investment industry at large continues to see social performance monitoring as less than top priority.

One possible explanation is that some impact investors are skeptical of the role social performance management can play in the success of a microfinance business, thus seeing it as a good but not essential practice. But in doing so, they are missing the bigger picture. Social performance is much more than a practice to monitor the advancement of a social mission. It is a full-fledged business strategy that positively affects the financial performance of an institution and that can make a substantial difference to business success, especially for FSPs operating in competitive markets.

A report I recently co-authored with Meraj Husain—based on our study of 780 FSPs reporting to MIX Market, spanning across 96 countries and serving more than 95 million borrowers—shows an association between social performance management, and stronger FSP financial and operational performance. In particular, we saw significant correlations in five areas of social performance management that MIX Market frequently tracks:

1. A board of directors with social performance expertise

Most FSP board members have limited experience in social performance management. Our analysis shows that organizations that have board members trained in social performance also tend to have better portfolio quality, productivity, and efficiency. In particular, they have fewer written-off loans (loans the FSP does not expect to recover) and lower operating expenses than their counterparts by three percentage points.

Investors can help FSPs identify the most qualified people to sit on their boards when transiting members and encourage existing members to get social performance training. They can also help select a champion or establish a committee to monitor relevant social performance practices and report back to the board.

As an example, the board of the Peruvian NGO FINCA Peru started by discussing social performance issues informally and later created a more specialized social performance committee in charge of reviewing areas not related to financial performance assessment, such as client outreach and satisfaction, and quality of services. The organization formed a board comprised of people with both financial and social expertise, especially in the areas of rural outreach and gender—a successful mix that made the organization not only an example of commitment to its social mission but also a financially sound institution, with one of the lowest operating expenses and portfolio at risk in the Peruvian market.

2. Progressive human resources policies

Our research also shows a connection between human resources (HR) policies that include social protections (such as pension contribution or medical insurance) and FSP staff productivity, staff retention, and portfolio quality. And integrating social performance goals (such as high-quality data monitoring) with staff incentive schemes (whether recognition or monetary compensation) correlates with higher productivity levels. The cost of failing to invest in people is high: Besides the associated staff and client recruitment costs that come with high turnover rates, we found that a five-percent increase in staff turnover rate correlated with a three-percent decrease in borrower retention rate.

It follows that investors should pay attention to HR policies, staff incentives, and compensation packages at the FSPs in which they invest.

After a period of high portfolio growth (quintupling in size over five years), the Lebanese nonprofit Al Majmoua adopted a series of innovative policies to improve staff and client retention. It began carrying out field visits with potential new loan officers before recruitment, assessing whether job candidates’ values aligned with the institution’s social mission, recruiting more women to reach out more female clients, and adopting measures to help female staff achieve better work-life balance. Al Majmoua is a leader in the Middle East and North Africa (MENA) region, known for both its social commitment (it recently expanded to serve Lebanon’s Syrian refugee population) and its financial viability.

3. Borrower retention tracking

There are numerous reasons to monitor borrower retention. For one, retention rates are important for gauging client satisfaction, especially in markets where there is a considerable gap between demand and supply of financial services. Second, retaining clients means that institutions invest less time and money in attracting new ones. It also increases loan officers’ productivity: Our research found that just a one-percentage-point increase in retention rate is associated with a higher staff productivity (approximately 20 borrowers per loan officer) and with a $4 decrease in average cost per borrower.

Borrower retention rate is known for not being easy to track; FSP management information systems (MIS) often do not take into account clients who are currently not taking a loan but expect to take a new one in the future. But for those institutions whose MIS can provide such data, investors can monitor retention ratios using borrower retention calculation, or simplified formulas adopted by MIX and raters that can provide an approximations. Above all, investors should monitor retention trends through market assessment so that they can understand whether clients leave because they no longer need financial services, because they are dissatisfied, or because they prefer a competitor.

Alalay Sa Kaunlaran (ASKI) a Philippines-based NGO providing microfinance services to more than 130,000 clients, combined assessments on consumer satisfaction and protection with client exit surveys and client complaint mechanisms via SMS. The data ASKI collected revealed problems that it addressed by adopting significant operational changes related to loan methodology, price calculations, loan size amounts, and mechanisms for complaints resolutions. These changes dramatically reverted the drop-outs, registering a record of retention rate of 80 percent from a baseline of 68 percent just two years earlier—a significant advancement for an institution operating in a highly competitive microfinance environment.

4. Poverty targeting

We found that operating expenses of institutions that exclusively target the poor are higher by seven percentage points, but they also have lower costs per borrower—by $43—compared to institutions with a more diversified poverty strategy. One possible explanation is that these institutions are presumably adopting the group-lending methodology—whereby loans are distributed to a group of clients rather than to individuals, whose members guarantee the repayment of each other’s loans—often used to target the poor, which ultimately might reduce costs per borrower. In addition, institutions that exclusively served the poor reported bringing on approximately 50 additional borrowers per staff member compared to institutions that also serve low-income clients or that did not have a specific poverty strategy.

When choosing to invest in an FSP that targets a poorer segment of the population, investors need to be aware of the higher operating expenses, and ensure that any efforts to lower such costs or promote portfolio growth is not detrimental to the FSP’s main target market or mission.

An example of an FSP that stays true to its mission of targeting the poor while maintaining good productivity and efficiency levels is Agora Microfinance Zambia (AMZ), a microfinance institution that serves more than 10,000 poor clients. AMZ’s strong and efficient client service means an entire village’s loan applications can be filled out within a day, loan collection is speedy, and rules are simple. This efficiency allows it to reach remote rural areas and handle high numbers of clients per loan officer. There is no corner-cutting here, however; AMZ still conducts detailed clients assessments and does not compromise on the quality of risk assessment, as reflected by its operational figures: Over the past two years, it has increased  productivity from 250 to 500 borrowers per loan officer (Africa’s average is 369) and by reducing portfolio at risk from over 5 percent points to under 1 percent.

5. Female client targeting

Our research shows that identifying women as a target market is also linked to better overall performance. FSPs with a specific focus on targeting women consistently show better portfolio quality, efficiency and productivity.Recruiting female loan officers is one way to recruit female clients; our research shows a higher ratio of female loan officers is linked to higher number of female active borrowers, although the presence of women at the board and management levels does not seem to have the same effect. Data also suggests that offering women’s empowerment services—such as business and leadership training—may be linked to lower portfolio risk.

Investors with an interest in women’s empowerment might also consider looking at key financial indicators disaggregated by gender (percent of new women borrowers, average loan size per woman borrower, women borrower retention rates, women’s portfolio at risk, women’s staff retention rates) that are relatively easy for an FSP to track and that could provide important information on how well the institution is targeting its female clients.

Several institutions are using a mix of financial and non-financial services targeted to women that are also financially viable. Microfund for Women (MFW), the biggest FSP in Jordan, achieved full financial sustainability in 2002 and now serves more than 125,000 entrepreneurs. In addition to credit, MFW provides a range of non financial services tailored to women's specific needs to help them improve their business skills and also introduced  the first microinsurance product in the MENA region, designed to help women and their families  cope with incidental expenses associated with medical fees, lost income, and childcare.In addition, as Al Majmoua in Lebanon, this FSP also started this year to successfully offer their credit services to Syrian refugees in Jordan, thus expanding their mission to serve entrepreneurs also among this vulnerable segment of population in Jordan.

These five areas of social performance significantly correlated with the areas of operational and financial performance we analyzed. But this is not an exhaustive list; it is important to notice that our dataset captures only a subset of indicators identified by the SPTF Universal Standards, and the majority of data is self-reported (a third of FSPs were subject to MIX desk-review or other third-party validation).

Nevertheless, the bottom line is that impact investors today have access to a solid set of tools and data for the microfinance industry that make social performance a practice no longer difficult to monitor. What investors in this field need now is a shift in mindset—to start looking at social performance management as both the right thing to do in accordance with their impact mission, but also the smart thing to do in fostering successful businesses. 

Read more stories by Micol Pistelli.