Zero Tolerance for Past Due Loans

1. Zero Tolerance for Past Due Loans Controlling Loan Delinquency

2. Agenda • What is “zero tolerance for past due loans”? • Characteristics of loan delinquency • Costs of loan delinquency • Controlling loan delinquency • Bank image & philosophy • Credit methodology • Information system

3. What is “zero tolerance for past due loans”? • It is the bank management & staff’s attitude towards loan delinquency -- namely, that no level of late payment is acceptable. • It is an institutional culture in which late payments are simply unacceptable. • The bank must be willing to aggressively pursue past due clients, whatever the cost, to establish and maintain zero loan delinquency.

4. Why zero tolerance? • Loan delinquency can weaken and ruin a lending institution. • Unless aggressively controlled, delinquency can spread and worsen, leading to high levels of default. • Pursuing the collection of delinquent loans swiftly and aggressively facilitates the development of a strong credit discipline among the clients.

5. Characteristics of loan delinquency • Delinquencies should be seen as direct costs to the bank. • Delinquency and loan losses imply postponed income, lost income, and lost portfolio to the bank. • Likewise, some measures aimed at reducing delinquency are costly (e.g. client follow-up & monitoring costs)

6. What makes loan delinquency distinct from other problems? • The costs of delinquency are hidden. The true level of loan delinquency can be concealed, making it difficult to recognize the true extent of the problem. • Lenders tend to attribute delinquency excessively to external factors. Consequently, they do not confront and resolve the causative factors within their control. • Delinquency is contagious. It tends to spread and worsen, leading to high levels of default, unless it is aggressively controlled.

7. The costs of delinquency • Quantifiable costs • Non-quantifiable costs

8. Quantifiable costs Delinquency has numerous effects on a bank’s • Cost structure • Income • Financial condition

9. Non-quantifiable costs • Deterioration in staff morale • Breakdown of credit discipline among clients • Ineligibility to access funds for portfolio expansion from external funding sources • Less access of microenterprises to formal credit -- the bank has less funds to lend while other banks will be more reluctant to lend. • Damage to delinquent borrower’s reputation and business, leading to a more desperate economic situation for his/her family

10. Borrowers may think it is better not to repay their loans. • Whether a borrower perceives a cost or benefit to late repayment or default depends upon the policies of the bank. • Borrower may find it more profitable to keep using the loan funds even after due date, rather than paying it back on time, if the interest rate is low, or there is little or no late payment charges. • Likewise, if the bank does not use vigorous collection techniques, or offer repeat loans or other incentives, the client may very well maximize his/her economic benefits by paying late or not at all.

11. Controlling loan delinquency • Uncontrollable factors • Controllable factors

12. Uncontrollable factors • Natural disasters (fire, typhoons, flood) • Government policies (e.g. crackdown on street vendors, phase out/banning of tricycles in major streets, relocation of public market to a new site leading to dislocation of many microentrepreneurs) • Illness or death in the family • Slow down in the growth of the local economy

13. Mitigating measures • Emergency grace periods on outstanding loans • Emergency or insurance funds • Smaller loan sizes & longer terms • Client’s deposit • Restructuring & refinancing loans (only when absolutely necessary)

14. Controllable factors • Bank image & philosophy • Credit methodology • Information systems

15. 1. Bank image & philosophy • The bank’s image is determined by the way it presents itself, to the sector and handles its relationships with microentrepreneurs. • The bank must view its microfinance activity not as charity (i.e., helping the poor), but as a profitable business. • The bank can still project an image of being a socially responsible institution, but the borrower’ s obligation to pay back their loans on time should be made clear. • It has to be emphasized that the bank has very limited resources and that it wants to lend to more people. If the loan is not paid on time or not all, it is not only the bank that suffers, but the low-income people themselves.

16. Zero tolerance: Creating an institutional culture • Begin with the premise that no level of late payment is acceptable. • This attitude should be ingrained, initially among the members of the microfinance unit, and eventually among all employees of the bank. • Also emphasize the need for on-time and full repayment continuously among the borrowers in all stages of the lending cycle.

17. Some Examples Informal moneylenders • If a borrower does not have enough cash to pay his/her loan amortization for the day, the moneylender either waits until the borrower has enough cash from sale (“tutok”)s, or just takes some of the goods sold by the borrower (“hakot’) . CARD (San Pablo City, Laguna) • Centers do not allow members to leave the meeting until all loan amortization payments due for the week are collected. TSPI (Metro Manila) • Loans staff are not allowed to report back to the office until 100% of their loan collection target for the day are collected.

18. RB Sto. Tomas (Davao Province) • A borrower (sari-sari store owner) claimed that she did not have enough sales for her daily amortization payment. The microfinance staff stayed in the store and took the proceeds of the sale from each of the store’s customers until she had collected the full amount due for that day. New RB of San Leonardo (Nueva Ecija) • For every visit/collection attempt, the borrower is charged a penalty of 5% on the outstanding loan balance and a collection fine of P1,000. • Sending delinquent borrowers to jail. • Daily management meeting on past due loans.

19. Other MFIs • The names of delinquent borrowers are displayed prominently in public places (e.g. post office). This puts pressure on the delinquent clients into paying their loans.

20. 2. Credit methodology • Client selection • Incentives to clients for on-time payments

21. Client selection • Select clients based on personal factors and moral guarantees, rather than business factors and physical guarantees. • Give priority to applicants with existing enterprises. • In individual lending, the loan officers should become intimately familiar with the neighborhood in which they work. • Check court records (judicial courts and barangay council) for complaints related to non-repayment of debt (e.g. bouncing checks, collection of a sum of money, estafa).

22. Good microenterprise clients of the bank can be an excellent source of information • Orient all prospective clients and and make sure they understand the bank’s policies and procedures, especially the incentives for on-time repayment, and the penalties for late and non-repayment. • If there is no group guarantee, require a co-maker or a physical guarantee on paper (e.g. stock inventory, small household appliances).

23. Client incentives Access to subsequent and bigger loans • the most critical, most powerful factor affecting repayment Interest rebate • Charging an extra interest, then returning the extra interest to borrowers who pay their installments fully and on-time

24. Penalty charges Charging additional interest on payments made after due date. Without a penalty charge, good borrowers effectively subsidize delinquent borrowers. Savings People tend to repay loans when they know that it is their own savings that is being lent to them

25. 3. Information systems • A good information system permits timely follow-up and monitoring of loans. • Follow-up visits are imperative in preventing delinquency. But such visits are contingent upon the field staff having accurate and timely information. • The less time that the field staff spend in figuring out whose payments are due when, and whose are already late and by how much, the more time they can spend with the borrowers

26. Importance of a good MIS to the loans staff A combination of good and timely reports enables a field worker to manage hundreds of borrowers and minimize delinquency by: • Ensuring that all new borrowers receive a follow-up visit within days of loan disbursal, so they understand the bank will not “forget” about them; • Visiting borrowers quickly after a payment becomes past due to determine the problem and help solve it; • Processing repeat loans in a timely fashion for good borrowers to encourage continued on-time repayment; • Detecting trends in the portfolio (such as high delinquency among borrowers with certain activities) that might help identify strategies for reducing delinquency.

27. Importance of a good MIS to loans staff supervisors A good MIS can provide the MFU supervisors with tools for analysis for understanding the extent of the banks’ delinquency problem and responding to emerging arrears problem. Variables to examine in analyzing delinquent accounts, includes: • Age of arrears • Loan officer & geographic location of the borrowers • Loan type & size of loans • Activity of the borrowers • Gender • Number of loans

28. Strategies for reducing present levels of delinquency • First, the bank should analyze whether the loan sizes and terms are appropriate for the borrowers. • Second, it should examine whether there are sufficient incentives for borrowers to repay. • Third, a trend analysis focusing on different variables, such as activity, size of loan, and geographic area, might reveal a specific cause of delinquency which can then be addressed. • Finally, the bank might want to consider the implementation of an incentive system for field workers that will encourage them to prevent unnecessary late payments.

29. Summary • High levels of delinquency should not be blamed on the borrower group but on the credit institution. • To mitigate the effects of uncontrollable factors, the bank should be able to adjust its methodology, and quickly identify and resolve the factors on a case-by-case basis. • Whether borrowers pay back loans on time depends, to a large extent, on the borrowers’ perception of the costs and benefits of timely repayment

30. A good information systems is critical to controlling delinquency. • The refinancing and rescheduling of delinquent loans should be used sparingly in specific justifiable causes. • Creating a culture of zero tolerance for past due loans within your bank starts with you.