NOTE 11 (Continued)

NOTE 11: ON MICROCREDITS (Continued)

In the previous Note I started to introduce some brief suggestions to strengthen the relationship between debtors and creditors in the six points raised; (1) Trust (2) Sincerity, (3) Discipline (4) Character, (5) The assessment of the creditor and (6) The continuity of the relationship, now I will continue with some suggestions:

1.      Non-regulated MFIs should make strategic alliances with regulated financial institutions to open and operate savings accounts with customers with a credit agreement according to the savings portfolio of the ONG’s clients.

2.      Loan Officers must be given training and empowerment to find appropriate solutions for delinquent customers in their portfolio.

3.      Messages to encourage good payment should be added to materials permanently, to reinforce good behavior.

4.      The presentation with the “duties and responsibilities of the debtor” should be done before signing the credit.

5.      Open doors policy must be kept to analyze the problems of borrowers who have trouble paying their loans.

6.      To the IMF the first in the paying line to collect, before others do.

7.      Shield for overindebtedness, by managing information sharing between local MFI.

8.      Develop financial education efforts, as a part of the Credit Officers duties.

Let us start with point No. 1, "Savings Deposits": all countries required MFI to be supervised by the Banking Authorities to take deposits from the public, this will not be the case of NGOs, which cannot receive deposits from the public. The non-regulated Savings and Loan Cooperatives can receive savings only from its members, either in the form of equity, savings accounts and term deposits. The regulated Savings and Loan Cooperatives, which are known as “Credit Unions”, are supervised by their Specialize or Official Authorities or by the Banking Authorities and can receive deposits from the public that are not members, but to receive credits these customers must become members. As you can see, the more limited institutions are the NGOs, but there are experiences: For example, Pro Mujer in Bolivia, created by Lynne Patterson and Carmen Velasco (https://promujerblog.wordpress.com/tag/carmen-velasco/). This institution reached a strategic alliance with FIE FFP (Today Banco FIE) to provide access of its members to have savings accounts (http://promujer.org/what-we-do/), generating loans for the NGO in the proportion of the savings received from Pro Mujer’s members, for Pro Mujer to give loans to its affiliates. There are thus solutions to financial services even when NGO are not regulated.

Moving on to point No. 2, "Train the Credit Officers to control the underpayment." Default is more likely to arise during the period of repayment of a credit (70%) than by failures in the assessment of the applicant to approve them (30%). I will address first the failures in the credit application. The first thing is to start not from the amount the applicant has requested, but from what is his/her actual payment capacity. Traditionally what is requested by the applicants is the starting point in a loan application, but they have no idea of what their paying capacity is; what is worse, when it arises, they become frustrated. I have never denied credit to anyone, but I have always calculated first the real paying capacity, to offer the maximum credit that it can be given, so that it can be paid back comfortably, if there is no overindebtment. It is very simple, from the start and as an initial verbal approach, the documents will come later, fill out a form with the fixed and monthly income variables of the family group that acts as guarantor of the loan. Apply a percentage of what should not exceed the monthly payment (I usually apply less than 20% of the income), this would be the maximum monthly fee. Then I calculate the factor for rate and term for a one unit of money and divide the maximum payment by this factor (Four decimal places will do). The result is the maximum loan amount the applicant can afford according to his/her income and that will be the loan amount that I will offer: If it is accepted: Well, if not, the applicant will reject the credit offer and leave. At this stage, no documents are used because it also serves to see the honesty of the applicant. If he/she accepts the credit offer and the documents are presented, the income is significantly lower, it can be assumed a lack of transparency from the beginning: Then what confidence there will be to learn the truth during the period of payment (70%)?. Now let us aboard the risks that occur during the payback period. It obeys a set of circumstances that put pressure on the Credit Officers to meet the goals of bringing new credits: (a) The stability of their income, so they must produce enough new business, (b) The competition from other Microfinance Institutions (MFIs), (c) The credit conditions demanded by the applicants and (d) The credit offers from the other MFI. In a competitive market, there is a tendency to try to offer more financial advantages than to better the ratio "price-value" of the financial products. What does this means?: It is easier to offer the maximum terms for the loans and better conditions than to add non-financial advantages to financial products to improve their value. Take an example: If we add to the loans the possibility of obtaining discounts on the inputs bought by Microentrepreneurs by negotiating with suppliers; for example: Creating a virtual "Discount Club", it is possible to improve these ratio by increasing the value while maintaining the financial "price and conditions" of the loan equal. I developed these services many times in various countries and have always found the distributors or sellers very receptive when negotiating to promote their business among the FMI customers in exchange for discounts. On the other hand, facilitating loan payments and improving the response speed of approvals and disbursements makes a difference to attract good payers. I think the most effective way to compete is based on service. However, I have observed that the longer term of the loans is always offered first, but there can be a problem: For example, to finance a know inventory turnover of a Microentrepreneur with a longer term loan, can be not only counterproductive, it can also fatal. If we know the time and rotation of an inventory, it makes no sense to give longer terms for payback, because it would also lengthening the time required by the debtor to renew its credit and in the meantime: How it will be paid the following rotations of the inventory, if these have been covered with a loan with a longer repayment period?. The problem is that the Credit Officers are trained on financial issues but they are not trained in professional selling of what they offer. Selling consist: First, to detect the needs of customers and to show them the best choice or "tailored suit" of financial products that satisfies these needs. According to my experience, the defaulting of a loan is due to five factors: (a) The intention of paying irregularly even not paying the loan, which it had to be detected in the application phase. (b)The external factors of overindebtedness; which can be controlled by creating a mini-credit bureau, even with a small group of MFIs, because experience dictates that debtors always resort to the same kind of institutions. (c) The relative importance of the institution, that places it at the top of mind of the debtor, when paying back. (d) The specific or exceptional situations in which the good payers may also fall in indebtness and (e) The lack of education and financial literacy. We will analyze and propose solutions "The intention of paying as they wish". There are people who live on credit, in the absence of a credit bureau or failing to access to know defaulters in other MFIs, the only way to detect them is by credit-structured interviews to detect inconsistencies in the application stage. Usually deception is associated with emotional stress, this is manifested by microgestures, strange attitudes, voice changes, etc., this implies that Credit Officers must learn to identify these and look for inconsistencies in the information submitted by applicants. On the other hand, a good sales person must be very observant to detect the needs of its current and potential customers, so this ability will also be helpful to a Credit Officer to evaluate loan applicants. If a group of MFIs in any area agree to exchange information on their bad payers, it is very easy to control a great part of the local overindebtment. One of the institutions becomes the monitor, receiving spreadsheets from the other MFI, listing their defaulters, consolidates the list adding its own returns it with all defaulters to each MFI in a spreadsheet ordered by the ID document number, which allows them to know who is indebted in another MFI. In fact, this system, has been mounted frequently and it is not necessary to know all the details of defaulter’s loans. To know the debtors ID, the number of installments in default, the amount of each installment of each credit in an MFI, is enough because the idea is for others MFI not give him/her loans until the debtor disappears from the default worksheet. The next item is the "relative importance of the institution", debtors establish a mental hierarchy in the sequence of how they will payback their debts, this means that the IMF should "remember" its debtors the maturity of the first installment, to ensure that the they internalize and add mentally the payment to the scheme of their mental hierarchies. In this sense, the comparative advantages of non-financial nature that the debtor values in an MFI play a very important role: (a) The quality and service excellence of the customer service. (b) The speed of approval and disbursement of the loans. (c) The advice and guidance received from the Credit Officer and (d) The non financial benefits he/she gets for free from the IMF. None of these reasons are financial. The reality is that it is harder for the competition to catch up in these areas, than to make adjustments on the financial issues to be competitive. Therefore, any MFI can be more competitive: For example, if it includes a free life insurance, disability and accident policy for the outstanding balance of the loans. This benefit could make the difference in non-performing loans placing the MFI in a stronger market position and more if the insurance is conditioned to be applied only to loans that are current at the moment of the sinister. The next point is "The exceptional situations of underpayment of good payers"; the reality is that there is a 70% chance that a loan comes in default, even in the case of good payers if the credit has been given in the right terms. However, even if they occur, immediate response of the Credit Officer will be necessary and empowering this employee is a must, to negotiate a recovery process in which helping the good payer is crucial. If the Microenterpriser gets sick, he/she will leave someone to run the business meanwhile, so it is essential that the Credit Officer reaches an agreement directly with the temporary person in charge of the business and maintain regular contact with the original debtor. First, to ask for his/her health and second to maintain contact and inform him/her of any rule’s change by the temporary person in charge that affects the MFI. Ultimately, the real owner is the one who has the authority to instruct the temporary in charge to act correctly. On the other hand, once the debtor rejoins work, if there are still any delayed payments, the Credit Officer should have the authority to agree with the debtor to carry on a recovery plan of the dues in default: For example, weekly installments that cover the next fee and offset some more money to recover the due payment. Finally, the aspect of "financial education", generally it is assumed in many MFI that debtors know about finance and that is not true, it is a very wrong assumption, so that Credit Officers must become “financial educators” to the debtors in order for them to manage better their money and therefore pay their dues on time. Because the more the customers know about finances, the better they will control their payments. I usually suggest to the MFI that before the applicant signs a loan it has to see a presentation with an electronic slides on "the rights and duties of a debtor", few credit customers read the contract. You will be surprised how many times an applicant decides after watching the presentation not to take the responsibility for a loan, if he/she want to have a good image with the MFI or may reduce the original loan amount, to lower the fee and be more comfortable. It is a misconception that an increased knowledge of finances, make harder the relationship of the debtors with the MFI, it is the opposite.

Last but not least, remember that a healthy loan portfolio is the sum of the credits granted and monitored well. Statistics only show what is happening in a portfolio these do not solve the risks mentioned here that are related with human behavior, not with finances.

jlinaresf@gmail.com 

NOTE 10

NOTE 10: ON MICROCREDITS (Continued)

In my previous Note, I commented on the psychological approach to the credit relationship that is also applicable to the Microcredit. I would pick up again this approach which is determined by six conditions governing the relationship between debtor and creditor: (1) Confidence: If a debtor receives a loan from a creditor, it is because the debtor conveyed enough confidence to the creditor to believe that he/she will fulfil the obligation. (2) Sincerity: When the debtor files the required documentation to the creditor and consistently answers the questions that are being presented, the creditor will not have any doubts about the situation of the debtor. (3) Discipline: When applying for a loan, if the debtor was verified in the credit bureaus and he/she appears as a reasonably good payer, it can be assumed that there is a disciplined behavior. (4) Character: This is represented by the paying behavior, transparency and the honesty reflected by the applicant or debtor. If these are present, the creditor will be confident ("Willingness to Pay"). (5) Assessment of the creditor: The debtor clearly understands the implied commitment of the creditor, if he/she is a good payer there will always be an open door with the creditor. The latter clarify and strengthen the credit relationship in the long term and (6) Continuity of the relationship: Both sides tacitly agree that the relationship will be prolonged as much as possible in the future, if both are satisfied.

Perhaps some financial experts criticize me for this "soap opera" with all their right and all critics are constructive but as psychologist who has worked more than 46 years in the financial sector in 27 countries, I do not think the financial and legal approach is the best, less the unique platform for qualifying and resolving successfully a credit relationship. Hence, the above six points show me the basis for that relationship. As I think, there are better ways to manage a credit than those used traditionally, and still are being used today. In my opinion, this brought the world to the "credit crunch" and the recession. At least, I am proposing a new approach on lending relationships that it has worked for me in the practice.

As a marketing person, I have heard MFIs frequently say that the pressure of competition, forces them to act following the strategies of others in the market. If, competitors were in handling the lending situation, that would be right, but they do not, so it will be the worst way following them and falling in the risk of overindebtness with the customers. The best way, it is always staying one-step ahead of the competition with innovative and creative ways to attract new customers and keep existing ones, with an excellence in service and a quality of the customer service. MFI that responds to these two actions will lead the market, even if it is true that with time their actions will be imitated, the service excellence will shield their customers against the “siren songs” of the competition.

I will now analyze the credit from the perspective of previous six-points. In the last Note I commented that the risk of default is tripled during the life term of a loan, in relation to the risk of a wrong applicant qualification. I also commented that credit has two very distinct phases: The application phase and the payout phase. The first it is total and absolute responsibility of the IMF, so if a mistake is made, the institution can hardly attribute the error to the debtor and in the second, while the debtor is paying properly, an harmonious relationship is maintained by the creditor. But when the debtor falls behind, the attitude of the MFI gives a 180 degree turn in the way the customer is treated, assuming a very aggressive position, this radical and contradictory change is very far away from the relationship when the debtor was paying correctly. This change is so abrupt and excessive in many cases, which resulted in the scandal Andhra Pradesh in India, which caused 88 suicides in 2010 and has very worried to global microfinance sector.

The credit problem arises when the Pandora's Box opens, because a chase begins, in many very cases violent, with equal treatment for all defaulters and as insistent with those who cannot pay and those that do not have the wiliness to pay, rather than objectively analyze each case in search of solutions. I have always found there are always solutions, either preventive or corrective. Such as: (a) Use fractional collection procedures to avoid the extreme actions; (b) Educating financially the debtors on credit risk and the consequences of overindebtedness as preventive and on the in the best way to manage their money and (c) Watching the defaulters behavior to detect early problems. However, the IMF's emotional reaction to the risk of losing income, sends the wrong messages to the customers and the personnel, this last if they are not trained to manage this situations, the result is catastrophic to both parties: The MFI and the defaulters. I will discuss each of these aspects with examples.

I will start with point (c). Earlier I mentioned how you should handle the issue of competition and points (b) and (c) which are closely related, I will treat them jointly: The way MFI publish in advertising to their customers, in many cases is more harmful than beneficial. To demonstrate this I will present two typical examples that I experience, one in relation to savings and other on loans: The financial community competes by offering higher rates to depositors of savings, which has led savers to give an exaggerated value to the percentages more than money value of interests. By not educating financially on percentages, depositors have lost their meaning, except that some are higher than others are. Take the case of ordinary savings account in two MFIs: One offers an interest rate of 5% per year and another 3% annually, but none explains in the advertising that the interest is calculated on the average daily balances. However, if both show an average balance of $ 100 at the end of the month, the interest paid that month would be $ 0.25 for the 3% and $ 0.41 for the 5%: It is clear that the difference in money between the two accounts would be only $ 0.16, while the difference between the two rates would be 2%. The first difference is negligible while the second is significant and this is what it had been publicized by the two MFIs: Do you think many people would decide to open the account in one or another by such an small money difference?. The example on loans: IMFs tend to offer from the beginning and automatically the maximum term of a loan, regardless of the purpose of the money itself, claiming that this is what the competition offers. However, if the loan is to be used as working capital to renovate an inventory that rotates every 3 months, it does not make sense to lend this money with a 12 months term for payback. Because during that period the inventory will have to be rotated 4 times, but the Microcredit will only cover one rotation and the debtor must wait 12 months to repay the loan and receive a new one: But how will the debtor will finance the inventory during that time?. It is the duty of the IMF to educate the client, showing that in savings is preferable to evaluate other differential advantages of the two accounts. in borrowing to use a 3 months payback term to cover each inventory turnover with a new loan and to adjust the amount of the new loan according to the sales: If the sales increases or reduce the amount will cover either a part of the inventory or a bigger inventory if the sales increase. Both examples are related to financial education that MFI should give their customers and that most of these do not do when they sell their financial products or services, regardless of what the competition does, you have to sell the best financial solution for each customer which it must be a “suit tailored” to their exact needs. Therefore the personnel must be train to sell professionally, properly and educate the customers of their portfolio.

In (b) is difficult for me to interpret the perception of some MFI that defaults in payments are a betrayal of the debtor to the MFI or a sin, so he/she should be punished severely, rather than give the loan officers the opportunity to seek a solution with his/her customers. In many cases default happens due to an undisciplined behavior or ignorance (That was one of the triggers of Andhra Pradesh), and customers all of a sudden see themselves placed into a serious problem with a bad end. An example that I notice in one of my clients: The IMF used to pursue defaulters the hard way. I trained loan officers to find out the root of the problems of the defaults, based on the knowledge gained with time and trust and the relationship developed with their customers and how to handle the default, as a professional selling situation to recover and avoid future defaults. It cost me more to persuade the managers in the IMF, who resisted empowering the loan officers, instead of scolding them hard when the defaults occurred. Microloans in this IMF were paid in monthly installments, so I prepared the loan officers to react casuistically and at the beginning of each month, when a debtor showed a delay in the previous month. They persuaded the debtors (Sell ​​professionally, is to identify the needs and persuade solutions) to set aside a weekly a portion of the monthly payment, visiting customers at the end of each market day in each week and to assure the deposit in a “deposit only savings account”. Loan officers motivated the client to deposit as much as they could give each week. So actually, they made four installments every month, one weekly, which eventually covered more than their monthly payment and a part of the default of the previous month, catching up on the next two months. The Microenterprisers realized that it was easier to cover in this way payments, as the debtors alleged that paying the full monthly quota with the income of the last week of the month was not always possible. What happened is that customers saw their business with a weekly perspective, leaving for the last week of the month the payment of the Microcredit. From that moment on, they changed the way to manage their payments and the defaulting problem was significantly reduced. Today, in this MFI the lending officers have enough authority to manage freely the defaults up to 60 days, as they are the most interested in receiving their full bonus that it was being reduced in relation to the default of their loans portfolio. The moral: Loan officers in addition to selling and processing new loans should educate customers. Therefore, they must be taught to learn how to do professional selling.

Many MFIs do not realize that every defaulter is a unique case and that aggressive, equal treatment and collective action for all defaulters could be counterproductive. IMFs directors and managers must act rationally, with tailored solutions in each case and seek effective and permanent solutions, as in the example above; preventing conflicts and strengthening customer loyalty and also achieving the cross-selling of other services offered by the MFI (The Savings Account opened by the customer).

In conclusion, the debtor suffered when he arrived the last week of the month and sales were not sufficient to cover the monthly payment, so no matter how much the MFI grind them the situation could not be resolved. Once the debtors change their money management behavior, default was reduced and additionally a new savings account was opened. At this point, the executives of an MFI have a helicopter view. It cost to delegate, so when there was the slightest default there was a tendency to generalize and enter into a spiral of "management by spasms" giving orders, demanding immediate results and scolding everyone, making loan officers lose their margin of maneuverability with their customers and even if they were well trained. This leads them to react thinking more about the survival of their employment that in the delinquent customers. This aggressiveness tends to be contagious, so the loan officers must be taught to sell; is not enough for them to have financial knowledge. I have seen Microentrepreneurs talk with emotion in front of loan officer on how he/she help them and taught them, because this "soap opera" creates intense bonds of trust and loyalty between clients and the MFI. The relationship between a teacher and a pupil is very strong, and the strongest is this link, the more difficult will be for the competitors to attract the good creditors away from the MFI.

I will end this note with some brief suggestions to strengthen this relationship:

1.       You must know the use of money of the Microloans before defining the term of the loan with the applicant, in order to reduce this term to a realistic minimum payment periods. This reduces the risk of defaulting, reduces the operative costs of the Microenterprisers business and as you know, a shorter lending period result in less risk for the MFI during the loan’s maturity and gives the Microenterpriser more flexibility.

2.       The lending officers have to know how to observe inconsistencies and gestures of the loan applicants that warn them of the risk of default. This ability is also important in loan recovering processes.

3.       Loan officers must observe and process the experiences that give effective and permanent solutions to settle the defaults, as seen daily in their work. These strategies should become permanent and shared with their peers.

4.       You must ensure the outstanding balance of loans to recover them in case of permanent disability or death of the debtor. The group insurance premium applied to the balance of Microcredit is cheaper than a recovery process.

5.       To provide the maximum deposit in the form of a limited savings account and/or fractional payments of the loans so that customers can design their own payment-saving solutions tailored to their need.

6.       Do not forget that Microentrepreneurs cannot be away from their businesses for too long and that they must be taught to manage their money that includes reminders of the fractionated payments.

I will continue this issues in the next Note and as you can see the rating of debtors and portfolio recovery can be a marketing issue. Who'd say?.

jlinaresf@gmail.com