PERFORMANCE INDICATORS IN
MICROFINANCE
P.V. Viswanath
Learning Goals
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What are the different measures of an MFIs
performance?
How can these financial ratios be used to evaluate a
microfinance institution?
Caveat: Some of the ratios discussed here are more
appropriate to MFIs that are mainly involved in microcredit.
Much of this material is taken from the Technical Guide
published by MicroRate and the Inter-American
Development Bank, as well as from Armendariz and
Morduch, Economics of Microfinance
Four categories of indicators
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Portfolio Quality
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Efficiency and Productivity
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These ratios measure the efficiency with which the MFI conducts its
operations. MFI rates of efficiency are much lower than that of
commercial banks because their operations are highly labor-intensive.
Financial Management
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These ratios measure the quality of the MFIs loan portfolio. MFI
portfolios are generally of better quality than those of commercial
lenders.
These ratios ensure that there is enough liquidity to meet an MFI’s
obligations to disburse loans to its borrowers and to repay loans to its
creditors.
Profitability
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These ratios summarize the overall performance of the MFI.
Portfolio Quality
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Portfolio at Risk
Provision Expense Ratio
Risk Coverage Ratio
Write-Off Ratio
Portfolio at Risk
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PAR = Outstanding Balance in Arrears over 30 Days plus
Restructured Loans/ Total Outstanding Gross Portfolio
It shows the portion of the portfolio that is “contaminated”
by arrears and therefore at risk of not being repaid.
This ratio is relatively manipulation-free, compared to ratios
such as the repayment rate which may not take into account
loans that are past due.
In cases of agricultural loans, where there might be balloon
payments, PAR 30 ratios may be irrelevant because there is
no warning of non-repayment until the event actually occurs.
Loan Loss Provisions
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A loan provision records the possibility that an asset in the
balance sheet is not 100% recoverable. Provisions expense this
anticipated loss of value in the portfolio gradually over the
appropriate periods in which that asset generates income,
instead of waiting until the actual loss of the asset is realized.
Provisions are only accounting estimates and entries, and they
do not involve a movement of cash, like saving for a rainy day.
Loan loss provisions charged to a period are expensed in the
income and expense statement. The corresponding credit
accumulates over time in the balance sheet as reserves shown as
a negative asset. The accounting transaction is: Debit Loan loss
provision; Credit Loan loss reserve
Provision Expense Ratio
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Ratio = Loan Loss Provisioning Expenses/ Period
Average Gross Portfolio
The Loan Loss Provisioning Expense is an incomestatement number, not a balance-sheet number.
It represents the charge to income that is taken to take
into account future loan losses.
For non-regulated MFIs, this may be at the discretions
of the MFI and thus may be underestimated.
Even where regulatory guidelines are satisfied, an MFI
could show profits by scaling back on provision
expenses.
Risk Coverage Ratio
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Ratio = Loan Loss Reserves/ Outstanding Balance
on Arrears over 30 days plus Refinanced Loans
This shows what percent of the portfolio at risk is
covered by actual loan loss reserves.
Refinanced loans are added to the denominator
because a non-performing loan can be converted
into a performing loan by the simple device of
allowing the borrower to extend the payment
period or by refinancing it.
Write-off Ratio
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Ratio = Value of Loans Written Off/ Period Average Gross
Portfolio
This ratio represents the loans that the institution has
removed from its books because of a substantial doubt that
they will be recovered.
Loan losses or write-offs occur when it is determined that loans
are unrecoverable. Because loan loss reserves already
provided for possible losses, loan losses are written off against
loan loss reserves and are also removed from the outstanding
portfolio. The accounting transaction is: Debit Loan loss
reserve; Credit Outstanding loans
Write-offs do not affect the net portfolio outstanding unless an
increase in the loan reserve is made. When write-offs are
recovered, they are booked in the income and expense
statement as miscellaneous income.
Efficiency and Productivity
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Operating Expense Ratio
Cost Per Borrower
Personnel Productivity
Loan Officer Productivity
Operating Expense Ratio
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Ratio = Operating Expenses/Period Average Gross Portfolio
Operating Expenses include Personnel Expenses,
Administrative Expenses, Depreciation and any other
expenses necessary for the operation of the MFI.
Interest and provision expenses, as well as extraordinary
expenses are not included.
This ratio measures the institutional cost of delivering loan
and other services.
Operating Expense Ratios are related to loan size and
portfolio size.
Similarly, rural MFIs have higher operating expenses, since
their clients are more dispersed.
Hence one should be careful in comparing this ratio across
MFIs.
Cost per Borrower
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Ratio = Operating Expenses/Period Average Number of
Borrowers
This measures the cost of maintaining an active borrower. A
borrower is an individually identifiable person who has at
least one current outstanding loan. All borrowers in a group
loan are counted separately.
Since the size of the portfolio is not included in the
denominator as in the Operating Expense Ratio calculation,
MFIs with larger loans do not automatically appear more
efficient.
Pawn loans and consumer loans are excluded from the
denominator, since they require far less screening and
analysis efforts. (Why?)
Personnel Productivity
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Ratio = Number of Borrowers (excluding Consumer and
Pawn Loans)/ Total Staff
Since MFIs are very labor intensive, this is a very
important measure of efficiency.
Low staff productivity often is due to excessive
paperwork.
A variant of this ratio is the loan officer productivity
ratio, where the denominator includes all personnel
whose main activity is the direct management of a
portion of the loan portfolio; it does not include
administrative staff or analysts who process loans
without direct client contact.
Financial Management
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Funding Expense Ratio
Cost of Funds Ratio
Debt/Equity Ratio
Funding Expense Ratio
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Ratio = Interest and Fee Expenses/ Period Average
Gross Portfolio
This ratio measures the total interest expense incurred
by the institution to fund its loan portfolio. The
difference between the portfolio yield and the funding
expense ratio is a measure of the net interest margin.
The funding expense ratio plus the provision expense
ratio plus the operating expense ratio determines the
minimum lending rate an MFI must charge to cover tis
costs.
If the MFI uses non-debt sources of finance, obviously
this ratio underestimates the total cost of funds.
Cost of Funds Ratio
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Ratio = Interest and Fee Expenses/ Period Average
Funding Liabilities
The denominator contains all funding liabilities of the
MFI, including deposits, commercial funds, subsidized
funds and quasi-capital. It does not include accounts
payable, since these are short-term obligations not
directly related to the lending operations of the MFI;
neither are mortgage loans obtained to finance the
MFIs buildings, for the same reason.
This ratio measures the average cost of the company’s
borrowed funds and shows whether it has access to low
cost funding sources, such as savings.
Debt-Equity Ratio
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Ratio = Total Liabilities/Total Equity
Total liabilities include everything the MFI owes to
others.
This ratio measures the overall leverage of the
institution. Traditionally, NGO MFIs have low debtequity ratios, since their ability to obtain commercial
debt is limited.
Most MFIs have lower leverage than commercial
banks.
Profitability /Sustainability
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Profitability Ratios
 Return
on Equity
 Return on Assets
 Portfolio Yield
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Sustainability Ratios
 Operating
Self-Sufficiency
 Financial Self-Sufficiency
Return on Equity
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Ratio = Net Adjusted Income Before Donations (after
taxes)/ Period Average Equity
This ratio measures the profitability of the institution.
This is more important for for-profit institutions. For
non-profit institutions, it can be used as a measure of
commercial viability.
When comparing across MFIs, differences in
accounting policies have to be taken into account.
Return on Assets
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Net Adjusted Income Before Donations/Period
Average Assets
This is an overall measure of profitability that
reflects both the profit margin and the efficiency of
the institution, as can be seen from the following
identity.
ROA = Net Adjusted Income/Revenue x
Revenue/Assets.
Portfolio Yield
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Ratio = Interest and Fee Income/ Period Average
Gross Portfolio
This measures how much money the MFI actually
collected from its clients.
A comparison between the portfolio yield and the
average effective lending rate gives an indication
of the MFI’s efficiency in collecting from its clients.
Since portfolio yield is a cash measure, it is not
affected by accrual accounting practices that might
mask bad loans.
Operational Self-Sufficiency
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OSS = Operating Revenue/(Financial Expense + loan-loss
provision expense + operating expense)
Revenues come from interest and fees paid by borrowers, as
well as income from investments and from other services (e.g.
sales of insurance products)
The denominator measures the cost of raising capital.
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It includes the interest and fees that the institution pays to
commercial banks, shareholders and the other investors.
It includes interest paid to depositors.
The loan-loss provision is the amount set aside to cover the cost of
loans that are not expected to be recovered.
Operating Expenses include rent, staff wages and transport costs
among others.
Operational Self-Sufficiency
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A value of 100% or more for OSS indicates full
operational self-sufficiency; such an institution does
not need outside support.
A value under 100 indicates that the MFI relies on
continued outside funding to maintain its current
level of operation.
However, some of the operations of the MFI may be
subsidized. In order to adjust for this, we have the
financial self-sufficiency ratio.
Financial Self-Sufficiency
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FSS = Adjusted Operating Revenue/(Financial Expense + loan-loss
provision expense + operating expense + expense adjustments).
Operating Expenses are adjusted for subsidized cost-of-funds and
for in-kind donations.
Cost-of-funds are computed at market rates and the difference is
added back to the financial expense.
The market rate used should be the prime rate, adjusted for the
riskiness of microloans.
In-kind donations add in the cost, or fair market value, of goods
and services that the MFI does not pay for but that are important to
the operation of its business. This could include technical advice,
training, rent, use of transport and so on.
If FSS is below 100, the institution is considered subsidy-dependent.