In the previous article, the author reviewed the need for credit risk management in microfinance institutions. Small scale microfinance institutions constitute a sizeable chunk of the entire microfinance industry in India. Owing to the large amount of credit risk faced by microfinance institutions today, the numbers of approaches and techniques have been devised by them in order to mitigate the risk pertaining to the failure of repayment by the customers. Such techniques are concerned with reviewing the portfolio of the customers completely and studying the sectoral trends of the demand of loans with the ultimate aim to minimize the loan losses. This motive is achieved by the banks by the way of following accurate customer scrutinizing process and close monitoring. Therefore, the small scale microfinance institutions are deprived of much financial assistance as a result they only employ the traditional methods to manage the credit risk.
Various tools have been put into use by the small scale microfinance institutions to develop the culture of loss minimization in their organizations. There is a dire needing felt for such tools and techniques that have been adopted from other financial institutions. These techniques are varied as per their customers and the environment, to mitigate the risk of loan losses.
Group lending to minimise risks
Group lending is the technique that is extensively used by small scale microfinance institutions as a risk management technique. Under this system the credit is provided to the borrowers without collateral who get together to form the groups. The method is undertaken eagerly by the microfinance institutions due to the feature of joint liability. This risk management technique is related to the process of information asymmetry or the inadequate information wherein the step of moral hazard taken by the customers through switching to the risky projects leads to increase in the liability of other members as well (Kodongo & G.kendi, 2013). This further helps in supervising of the steps of member by the social group members as they maintain the peer pressure.
Progressive lending to mitigate risk
Progressive lending or step lending is another risk mitigating tool under which the aim of the lender is to check the loan repayment capabilities and records of the borrower, concurrently with providing him with the loan. As such, the loan is given in the small amounts to the borrower at the outset. Consequently, the amount is augmented based on the loan repayment record of the customer (K & Veerashekharappa, 2011). The technique assures the competencies of the borrower simultaneously with providing them with the credit facilities.
Collateral substitute as a risk management too
It is an eminent fact that microfinance institutions deal in an environment where the collateral is scarce but they still manage to operate by the way of employing collateral substitute techniques. According to the technique an emergency fund is maintained by the small scale microfinance institutions by the way of collecting various valuables of the customers that may even include borrower’s degree certificates, important documents or identity cards. In addition, 5% of the amount in cash is also maintained to act as a collateral benefit in case of the failure of repayment (Ibtissem & Bouri, 2013).
Diversification of portfolio
Portfolio diversification assist the MFIs in re shaping their portfolios after assessing carefully the monthly trends of loss pertaining to loan repayment failure. It becomes a prominent need of such enterprises to continuously assess the trends of credit failure, check the status of repayment in various sectors and the risk profiles to limit the exposure of credit hazard (Idama, 2014). The loan structure must be decided for different sectors as per its various characteristics and the respective risk profiles. This is done in order to diminish the chances and trends of delinquencies.
Mitigating risk by offering business development services
Business development services complements micro finance institute’s methods of mitigation of credit risks. This method up surges the chances of the re payment by them. This facility goes beyond providing provisions of financial services to the clients and is concerned with increasing their technical, managerial and business skills (Ibtissem & Bouri, 2013).
Strict repayment schedules
Strict schedules for repayment needs strict guidelines in the cases where there is an absence of collateral and income of the clients is not assured. Risky borrowers are identified in the initial stages and the early warning signs are issued to them. Also, under such system, the additional income source of the clients is also assured to guarantee the payments and reducing the credit risks faced by the Micro Finance Institutions (Ibtissem & Bouri, 2013).
In conclusion techniques used by the small scale microfinance institutions are not modern like those employed by other medium and large institutions. However, they are beneficial in many ways in reducing the credit risk confronted by them. Modern risk management techniques guarantee repayment by adjusting policies as per the payment structure or trends.
- Ibtissem, B., & Bouri, A. (2013). CREDIT RISK MANAGEMENT IN MICROFINANCE: THE CONCEPTUAL FRAMEWORK. ACRN Journal of Finance and Risk Perspectives, 2(1), 9–24.
- Idama, A., A.I., A., & N., N. (2014). Credit Risk Portfolio Management in Microfinance Banks: Conceptual and Practical Insights. Universal Journal of Applied Science, 2(6), 111–119.
- K, N. K., & Veerashekharappa. (2011). Progressive Lending as a Dynamic Incentive Mechanism in Microfinance Group Lending Programmes: Empirical Evidence from India. Bangalore.
- Kodongo, O., & G.kendi, L. (2013). Individual lending versus group lending: An evaluation with Kenya’s microfinance data. Review of Development Finance, 3(2).