Part 1:

Understanding
Causes and Costs of
Delinquency
Group 1
TOPICS
1.1 1.2 1.3
What is delinquency What is Default Causes of delinquency
Management?

1.4 1.5
Costs of Impact of delinquency and default on
delinquency and financial statements and portfolio
default reports
Objectives:
By the end of the session participants will be able to:

• To Define delinquency and default

• Identify the main causes of delinquency
• To Calculate the costs of default
• To Discuss the impact of delinquency and default
on an MFI
INTRODUCTION
Self-sufficiency is not the same
as sustainability. Delinquency
has an impact on long-term
sustainability. Students will
learn about delinquency
management and interest rate
setting through the course's
structure. The use of
experiential technique
improves comfort.
 1.
1
What is
Delinquency
Management?
 Delinquency
Management
Delinquency is the situation where loan repayments are overdue.
Some of the definitions of loan delinquency are mentioned below:
• A delinquent loan (or loan is arrears) is a loan on which payments are past
due. (CALMEADOW).
• Delinquent loan is referred to as arrears or late payments, measure the
percentage of a loan portfolio at risk (GEMINI).
• Delinquent payments/payments in arrears are loan payments which are past
due.
• Delinquent loans are loans on which any payments are due (SEEP).
• Delinquent loans play a critical role in an MFI's expenses, cash flow, review
and profitability. Additional effort to collect delinquent loans usually mean
additional expenses for closer monitoring, more frequent visits to borrowers,
more extensive analysis of the portfolio, and so forth. The more time, effort,
and resources that are put into controlling delinquency, the less there are
available for the MFI to reach new borrowers and expand services or
outreach.
 Delinquency
Management
Delinquency of MFIs – A critical issue of survival. Delinquency is a
serious issue in MFI management. It is a question of survival and
sustainability for MFIs.
Microfinance institutions (MFIs) provide financial services to
low-income, economically active, borrowers who seek
relatively small amounts to finance their businesses, manage
emergencies, acquire assets, or smooth consumption (CGAP
2002) delinquency is risk that MFIs across the world are
confronted with on a daily basis.
 Delinquency
Management
• Delinquency is defined as a state when loans are not repaid by clients
at the scheduled time. The most serious risk for an MFI is credit risk
which results in poor loan portfolio quality and high delinquency. One
microloan does not pose a significant credit risk but from a few
delinquent ones it can spread to an entire portfolio.
• Delinquency is defined as something that has to be paid but is overdue
and unpaid. According to Clark and Stephens a delinquent loan is a
loan on which payments are past due or as arrears or late payments.
• Delinquency is often confused with default though the dictionary
meaning is almost the same there is a slight difference between the
two. client when repayment is not made on due date is when the loan
becomes delinquent.
• Delinquency refers to payments not made on due date.
 Delinquency
Management
In MFI delinquency may occur in credit, savings
and insurance:
• In the case of credit, delinquency occurs in the
case of delayed loan repayments – interest and
principal.
• In the case of savings, delinquency occurs in the
case of delayed savings deposits.
• In the case of insurance, delinquency occurs in
the case of delayed payment of premium.
 1.
2
What is Default?
 DEFAULT

Default occurs when a borrower cannot or will

not repay his or her loan and the MFI no longer
expects to receive repayment. The MFI may
continue its collection efforts. Usually, a loan is
declared in default when the borrower has
stopped payment on a loan for more than 2 or 3
due dates. The time period is determined by the
MFI.
 DEFAULT

The defaulted amount depends on how much is

outstanding when the borrower stops making
payments. Amounts that will have to be written off or
counted as loan loss may be different from the
defaulted amount depending on the ability of the MFI to
collect any collateral or on a guarantee..
 1.
3
Causes of Delinquency
 CAUSES OF
DELINQUENCY
There are diverse causes of delinquency. These can be broadly grouped into
two: external and internal causes.
External causes relate to:
• National Calamities and;
• Social Political Factors
Internal factors are either related to: MFIs or Clients or both.
• The internal factors related to MFIs are image and philosophy of the MFIs,
• Ineffective methodology of borrowing selection,
• untimely disbursement,
• Ineffective information system,
• Lack of follow-up,
• lack of staff incentives and
• loan products do not fulfil the client needs while those related to clients
corresponds to household emergency (illness, death etc.), project failure, etc.
 CAUSES OF
DELINQUENCY
Types of delinquency
◼ Emerging delinquency
◼ Endemic delinquency
Emerging delinquency – is the early stage of delinquency. It occurs when a customer
misses a loan repayment installment. If this is not addressed on time, it can lead to a
more serious problem called Endemic delinquency

• Emerging Delinquency : Warning

• Endemic Delinquency : Habitual
 1.
4
Costs of Delinquency and
Default
 1.
5
Financial Impact of Delinquency and Default
 Financial Impact of Delinquency and
Default

The income statement is a flow statement that represents activity

over a given period, such as a day, month, quarter, or year. The
income statement may also be referred to as a profit-and- loss
statement because it illustrates the overall net profit or loss for that
period (nonprofit MFIs may also use the terms net surplus or
deficit). The income statement summarizes all the revenue and
expense transactions for a defined period, usually the financial year
to date. The income statement may have two columns of data
showing present and past period performance to facilitate
comparison
 Financial Impact of Delinquency and
Default

Interest and fee income from loans are not received in a

delinquency situation. The MFI is short of what was planned
(in case of accrued interest). On a cash basis, the MFI
receives neither regular income nor income from other
finance-related services (penalties). - When the MFI has not
received repayment, it might be forced to use its investments
for loan disbursements. - Total operating income goes down
(very strong influence of delinquency).
 Financial Impact of Delinquency and
Default
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 Financial Impact of Delinquency and
Default

The Balance Sheet is a stock statement. In other words, it

captures the financial position or financial structure of an
MFI at a moment in time. A balance sheet is usually
produced monthly or quarterly (at a minimum, annually),
although MFIs with an adequate management information
system can usually produce a balance sheet on a daily or
weekly basis. The balance sheet summarizes the ending
balance of all asset, liability, and equity accounts. Recording
donations, grants, and in-kind contributions is important for
MFIs.
 Financial Impact of Delinquency and
Default

Its main components are assets, liabilities, and equity in balance,

specifically: Assets = Liabilities + Equity.
Assets:
– Cash due from banks goes down since less money is available.
– Reserves held in the central bank may go up. – Short-term
investments may go down.
– Impairment loss allowance should go up.
– Long-term investments could also be affected.
– Net fixed assets are not affected.
– Total assets may well go down; growth of negative assets
(impairment loss allowance) affects the total assets.
 Financial Impact of Delinquency and
Default

Liabilities:
– Compulsory savings will go down (when used as collateral to
pay off delinquent loans).
– Voluntary savings may go down (people will not place their
money in an institution with a bad reputation; high
delinquency means high risk for every deposit).
– Loans from commercial banks may go up to make up for loss
in voluntary savings (loans from commercial banks are a more
expensive source of funding).
– Loans in the central bank are probably not affected.
– Subsidized loans may go down because an MFI with a
delinquency problem may have a harder time finding
subsidized sources of funding.
 Financial Impact of Delinquency and
Default

Equity:
– Paid-in shareholders will probably not be affected by a
delinquency crisis unless the company is public.
– Donated equity of the prior year stays the same.
– Donated equity in the current year goes down.
– Prior year’s profit and loss stay the same.
– Current year profit goes down and loss goes up.
– Other capital accounts go down (not enough cash to fund
capital accounts; for example, a social development fund).
– The general conclusion of the impact of delinquency on the
balance sheet is that it shrinks, because the major asset
 Financial Impact of Delinquency and
Default

Cash flow As its name states, the cash flow statement is

a flow statement that represents the inflows and
outflows of cash during a specified period. Of the three
main financial statements, the cash flow (or sources and
uses of funds) is the statement MFIs are least likely to
create. A monthly cash flow statement is a valuable
liquidity management tool, and without sufficient cash,
MFIs cannot disburse loans, pay employees, and settle
debts
 Financial Impact of Delinquency and
Default

Cash flow from operating activities:

– Delinquency has a negative effect on almost all line items.
– Cash received from interest, fees, and commissions on the loan
portfolio goes down.
– Cash received from interest on investments goes down.
– Cash received as other operating revenue goes down.
– Value of loans repaid goes down.
– Cash paid for financial expenses on funding liabilities goes down.
–Cash paid for operating expenses increases.
– Value of loans disbursed goes down
– Deposits/withdrawals from clients might increase.
– Net cash from operating activities goes down.
 Financial Impact of Delinquency and
Default

Cash flow from investing activities:

– Changes in investments show a negative impact.
– Changes in gross fixed assets show a negative impact.
– Net cash used in investing activities goes down. Cash flow
from financing activities:
– Changes in commercial loans go up.
– Concessional loans are difficult to get when delinquency rises.
– Net cash provided shows a negative impact.
– Net annual increase in cash will be decreased.
– Ending year cash balance may be smaller.
– Almost every line of the cash flow is affected. Instead of
growing, the MFI has to think about how to survive.
 Financial Impact of Delinquency and
Default

A portfolio report and activity report link the loan portfolio

information of the three previously discussed statements—income
statement, balance sheet, and cash flow. The purpose of the
portfolio report is to represent in detail an MFI’s microlending
activity, present the quality of the loan portfolio, and provide
detail on how the MFI has provisioned against potential losses.
Unlike other statements, the design of this report varies from MFI
to MFI
Outreach:
– Outreach to new clients may go down.
– If using solidarity group methodology, the number of new
groups will also go down. – Client dropout rate will rise.
– Total number of clients will drop.
 Financial Impact of Delinquency and
Default

Loan portfolio:
– Total loans outstanding stay the same (delinquent loans stay in the gross loan
portfolio).
– Number of active clients falls.
– Average amount outstanding may fall (if the dropout rate rises and the MFI can’t
hold on to clients who have graduated to larger loan sizes).
– Write-offs increase.
– Total of loans disbursed falls.
– Average loan size is likely to fall.
– The proportion of first-time borrowers in the overall client pool may rise (because
existing clients may switch to another MFI).
– Average of effective loan terms may become longer because of rescheduling or
may become shorter because of an increase in firsttime loans for new clients.
– Number of loan officers could remain the same or fall (some people might be
fired).
– Portfolio-at-risk will probably rise (delinquency is contagious!).
– In summary, the portfolio report is greatly affected by delinquency and default .
 Financial Impact of Delinquency and
Default

Costs of Delinquency – Postponed Income Example:

The actual amount of postponed income can be deter- mined by
comparing the interest (and fees) received in a given month with the
interest (and fees) expected.

Portfolio on January 1, 2005

$100,000
Interest Rate (24% flat per year/12) 2%
Interest Due January 31 (2% x 100,000) 2,000
Interest Received January 31 1,500

If the MFI receives only $1,500 of the interest payments due by January
31, then its January income is $500 less than it should be because of
delinquent payments.
THANK YOU!
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