Lecture 10: Financial and Social Performance of MFIs Flashcards
Financial statements: overview
contain both stock data and flow data.
* Stock data: data at any moment, and
* Flow data: information on the flow or summary of transactions over a defined period of time.
include the following:
* Income statement: profit and loss statement
* Balance sheet: financial position
* Cash flow statement: sources and uses of funds
Financial Performance Monitoring
Financial performance is a function of revenue and cost.
* Revenue is received through interest, fees and other financial services (if applicable).
Expenses include
* Funding costs (interest paid on debt and to depositors), * Operational costs (such as staff costs) * Insurance * Transportation * Premises * Loan loss provisioning expenses.
How we measure financial performance
Efficiency and productivity ratios show the rate at which MFIs generate revenue to cover expenses. * Both ratios can be used to compare performance over time and measure improvements in a provider’s operations
- Efficiency refers to the cost per unit of output.
- Productivity refers to the volume of output (business that is generated) for a given resource or asset (input)
Profitability indicators show returns generated on assets (particularly the loan portfolio and equity).
Financial Risk Management: four core areas
- Capital adequacy,
- Liquidity management,
- Asset-liability management (ALM),
- Asset quality or credit risk.
Relationship between liquidity risk and credit risk
liquidity risk could easily lead to credit risk if borrowers begin to lose confidence in the provider’s ability to satisfy their demand for loans.
- Similarly, credit risk may aggravate liquidity risk and capital adequacy.
Capital Adequacy
For capital adequacy management, we determine whether
* Amount and type of capital a provider has is sufficient, and
* It is working as efficiently as possible
Financial service providers have different sources of funding:
* Equity * Debt * Deposits (if regulated as a deposit-taking institution
Capital Structure
* Capital structure policy involves a trade-off between risk and return.
Suggestion: If an institution can generate greater returns on its operations (i.e., higher ROE or ROA) than the cost of debt, it may make sense to increase leverage, albeit in a conservative manner.
Liquidity Management
Assets are considered liquid if they are easily accessible and quickly convertible into cash.
- Effective liquidity management involves * Financing daily operations (including withdrawals, if applicable), * Minimizing the costs of holding idle cash
Liquidity and liquidity risk of an MFI can be evaluated by looking at the
- Structure of the balance sheet, * Different types of funding sources, and * Assets they fund.
Asset and Liability Management (ALM)
- ALM analyses the structure of the balance sheet.
ALM analyses, and seeks to balance between, the risks and returns inherent in the balance sheet structure concerning - Pricing and cost of funds, * Maturity of assets and liabilities, and * Currency of funding and currency of lending.
- ALM also tries to maintain a positive spread between * Interest rates earned (on loans and other interest-earning assets), and * Interest rates paid (on borrowed funds).
Credit Risk
Credit risk is the inherent risk faced by lending one’s resources to others. * That loans will not be repaid.
Portfolio analysis is used to understand and manage a loan portfolio over time. * Visits to clients are also an essential part of understanding and managing both credit and fraud risk in the loan portfolio.
Credit risk is the core risk affecting asset quality.
Three main concerns
Maturity Mismatch
Interest Rate Risk
Foreign Currency Risk
Maturity Mismatch
Maturity mismatch occurs if the maturity of assets differs substantially from the maturity of liabilities.
For example, a bank could have substantial long-term assets (e.g., long-term loans or mortgages), funded by short-term liabilities (e.g., demand deposits that can be withdrawn on short notice) or short-term commercial paper (a money market security issued by financial institutions to meet short-term debt obligations).
Maturity mismatch occurs if the maturity period of assets is higher than maturity period of liabilities.
Interest Rate Risk
Liabilities are in floating interest rate bonds (interest rate fluctuates with market conditions), but
- Assets are in fixed-rate loans.
- If interest rates were to rise, the cost of its funding could rise above the fixed rate it earns on its loans
Foreign Currency Risk
Some providers have significant foreign exchange exposure.
cross-border, fixed income investments denominated in foreign currencies
If the institution holds a currency that depreciates, foreign exchange losses are incurred when repaying the source of foreign funding.
Social Performance Management
SPM is not about proving impact, but on gathering information. * It allows providers to * Understand their clients’ needs and behaviours, and * Improve the appropriateness and effectiveness of financial services.
Booming economy or poverty reliance: MFI success?
How much of BRI’s success and financial sustainability during this period was due to
* Institution-specific practices, and * Simply because the economy was booming?
* Conversely, could the Grameen Bank achieve greater financial sustainability if it had operated in a more vibrant macroeconomic context?
For example, high growth can increase * Demand and create new niches for micro-enterprise; * Profitable expansion opportunities for existing ventures
A growing economy might also * Raise households’ current or expected future incomes to to take on more risk and invest capital in a business venture.
Instead, microfinance may depend on a poor economy to survive. * Perhaps it thrives in a vibrant informal economy * May not exist and/or grow in an economy where institutions develop.
