Programme methodology

In implementing the so-called "downscaling" approach, simply transferring knowledge or monitoring the credit lines provided by public-sector donors is not sufficient to create a sustainable supply of credit for the target group. Banks must make fundamental institutional commitments and achieve a volume of lending to MSEs which makes a substantial contribution to their overall revenue. Success requires that the owners of the banks be genuinely committed to developing MSE lending.

The credit technology developed and applied by the consultants is precisely tailored to the specific conditions prevailing in transition economies. Our experience has shown that if the main elements of the technology are applied consistently, loan delinquency can be kept at a very low level and microlending can be profitable.

The technology incorporates the following "best practice" standards developed and established in successful micro and small loan programmes around the world, including those in transition economies:

• Credit analysis focuses strongly on the prospective borrower’s ability to pay, primarily by making a realistic calculation of the cash flows of his or her business. The loan officer obtains the data needed to carry out a comprehensive cash flow analysis first-hand by visiting the loan applicant’s business premises.
• In order to gain a realistic assessment of the applicant’s business, loan officers will frequently insist on inspecting his or her internal managerial accounts. Loan officers are given special training in using a company’s internal accounts together with their own calculations of sales figures to arrive at a realistic assessment of the enterprise’s capacity to repay the loan it has applied for.
• The credit assessment gives due consideration to the specific characteristics of the applicant’s business. When applications are filed by relatively large-scale clients, the loan officer not only analyses the firm’s balance sheet and profit and loss account, but also performs cash-flow analyses and sensitivity analyses. In cases where the applications involve very small businesses - most of which are not fully formalised - the analysis of the business tends to be less detailed; in such cases, greater emphasis is placed on the borrower’s household and his or her social environment when making the credit decision.
• While the qualitty of assets pledged as loan security is important, this aspect of the analysis is given only a secondary priority in terms of decision-making.
• Initially, all credit decisions are taken by a credit committee. As the volume of small and micro lending business increases, appropriate decision-making and control mechanisms are set up.
• A low default rate is vitally important for the sustainability of the Programme. In addition to high-quality credit analysis, intensive monitoring by individually responsible loan officers is a key factor in ensuring good repayment performance. Loan officers are paid performance-based salaries; their compensation is a function of their productivity and the quality of their work.
• A powerful software package is utilised to support credit decision-making, manage the loan portfolio and supply information to middle and senior management.

It is often claimed that making individual micro loans is too expensive, and that even over the medium term it is impossible for lenders to cover their costs in microcredit operations based on individual loans. Our experience shows that this is not the case. An appropriate credit technology, such as the one described above, enables the financial institution to issue micro and small loans in a profitable way without burdening the customer with unnecessarily high borrowing and transaction costs. Cost coverage can be achieved if the interest rate charged realistically reflects the administrative and risk-related costs of providing finance to micro and small enterprises. This means that fair interest rates, while considerably lower than those in the informal credit market, will be higher than the rates ordinarily paid by customers of commercial banks. Micro and small enterprises usually achieve a very high return on equity and can afford to pay relatively high interest rates as long as the loan size remains within reasonable limits. The target group clearly benefits from an institution that charges lower rates than the informal competition. Moreover, it is in the institution’s own best interests to make a concerted effort to continuously lower its lending costs through efficiency gains, thus securing its long-term financial viability.

The best way to reduce costs in microlending is to build long-term relationships with borrowers. The reason for this is quite simple: The in-depth credit analysis needed for individual loans is very time-consuming, and thus expensive, especially for a borrower’s first loan. But if borrowers are satisfied with their initial loans, they will be inclined to apply for credit again, because micro and small entrepreneurs generally wish to access credit on a recurring basis. When a repeat loan is made to a given customer, the input needed for credit analysis will be lower. The borrower’s repayment history will be a good indicator of the advisability of granting further loans. Long-term credit relationships also lower lending costs because over time the loan size will increase due to the expansion of customers’ businesses, and also due to the institution’s increasing confidence in its borrowers’ willingness to meet their obligations.