GUIDELINES FOR EVALUATION OF NON- GOVERNMENTAL ORGANIZATIONS ENGAGED IN MICROCREDIT ACTIVITIES

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Doris Francis
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1 GUIDELINES FOR EVALUATION OF NON- GOVERNMENTAL ORGANIZATIONS ENGAGED IN MICROCREDIT ACTIVITIES The Technical Audit Unit of the Ministry of Finance has the duty of inspecting, appraising quality of performance, ascertaining value for money directed to different development programmes and advice the Government on corrective actions to be taken. The Technical Unit complements existing systems and procedures on public financial accountability by focusing on the technical aspects of project delivery. In this context, the present guidelines contain the approach that the Unit will utilize to evaluate the operations of all non-governmental organizations engaged in microcredit.. Non-Governmental Institution that comply with the conditions set forth in these Guidelines would qualify for continued government funding and to receive a recognition as MicroCredit Institutions (MCIs). Introduction According to the National Microfinance Policy 2000 (NMP), the Government on Tanzania considers microfinance systems as an integral part of the financial sector that falls within the general framework of its Financial Sector Reform Policy Statement of The overall objective of the NMP is to establish a basis for the evolution of an efficient and effective microfinancial system in the country that serves the low-income segment of the society, and thereby contribute to economic growth and reduction of poverty. In this context, the NMP covers the provision of financial services to households, small holder farmers and small and micro enterprises in rural areas as well as in the urban sector. Clients use these services to support their enterprises and economic activities as well as their household financial management and consumption needs. Financing for all types of legal economic activity is included, e.g. commerce, trade, manufacturing and agriculture. According to the NMP, a wide range of institutions will be involved in the provision of microfinancial services, including NGOs. It is expected that these institutions apply best practices to provide these services effectively, efficiently and sustainably, combining commercial financial principles with a

2 variety of ways to adapt service delivery techniques to the circumstances of low-income clients. Some of the best practices that should be applied by these institutions, particularly NGOs for the purposes of these guidelines, are: 1. Full knowledge of its operational costs and the market they face, in order to set their lending rate and the prices of other services at such levels that those costs are covered. 2. Adequate information systems to monitor the status of their loan portfolio, particularly in order to promptly manage delinquent clients and to recognize the cost of credit risk, by implementing an appropriate policy for provisioning and write-off of bad loans. 3. Transparent financial and operation information that gives a clear picture of the status of the organization, including outreach, profitability (net of any subsidies received) and portfolio quality. 4. Lending techniques and products adapted to the circumstances of low income clients, including the use of collateral substitutes and repayment incentives to protect themselves against risk. 5. Sound governing structures. Regulatory framework for microfinance Bank of Tanzania has issued the Microfinance Companies and Microcredit Activities Regulations , that contain accounting and internal control rules geared towards securing the adoption of best operational practices by banks and financial institutions engaged in microfinance. The National Board of Accountants and Auditors has, in turn, incorporated 2 these regulations into Tanzanian Financial Accounting Standards No. 8 Disclosures in the Financial Statements of Banks and Similar Financial Institutions, thereby making them of mandatory observance by all institutions that are engaged in microfinancial activities. An effective observance of these rules by NGOs engaged in microfinance, would go a long way in reaching the first four best practice objectives previously described. With regards to governance, the Ministry of Finance has 1 Issuance of these Regulations would be required prior to release of the Guidelines. 2 Modification of TFAS would be required prior to the release of these Guidelines.. 2

3 amended Public Finance Regulations in order to clarify that the Chief Executive Officers of NGOs that access public funds, have the duties and responsibilities of Accounting Officers under the Public Finance Act. Evidence of the observance with this regulatory framework on the part of an NGO, would allow it to qualify for government funding and to gain recognition by the Ministry of Finance as a specialized MicroCredit Institution (MCI). Guidelines for evaluation of NGOs as MicroCredit Institutions 1. Independent audit report prepared by an auditing firm registered with Bank of Tanzania, with an unqualified opinion and explicit certification of compliance with going-concern criteria. Auditing practices shall be in conformity with Tanzanian Auditing Standards (issued by the National Board of Accountants and Auditors) and accounting practices used in preparation of financial statements must be in conformity with Tanzanian Financial Accounting Standards (issued by NBAA, adopting accounting rules issued by BOT). 2. Specialization in financial services, certified by the independent auditor. No more than 5% of the assets or the administrative expenses should be associated with non-financial services. 3. Efficiency analysis: the final objective is to verify that the institution is both profitable and competitive. Although it is possible to speak in broad terms about benchmarks or targets of performance and comparison, the most useful application of efficiency indicators is within a single institution over time. Issues of comparability become secondary to trend; for example, an administrative expense ratio trending downward, or a client per officer ratio trending upward, are changes for the better. Increased loan officer productivity and portfolio quality help reduce total administrative and provisioning expense, yielding increased profitability. In this context, targets and trends will be used as qualifying criteria, particularly until the microfinance industry in Tanzania establishes standards of efficiency (as provided by the NMP). 3

4 Targets or benchmarks a) Profitability (Net income adjusted for inflation/net assets): more than 12% per annum b) Operating expense ratio (administrative expenses/average loan portfolio): less than 25% c) Portfolio at risk 30 days (Outstanding balance of loans with installments past due for 30 days or more plus restructured loans/total outstanding loan portfolio): less than 5% Trends Qualification for government funds could also be granted to institutions that show a positive trend in efficiency ratios, but have yet to reach the desired target or benchmark. For these purposes, positive trend is a yearly improvement of at least 15% in the ratio. Recognition as Microcredit Institutions should only be granted upon actually reaching the target or benchmark. Other performance indicators that could be analyzed to gain an insight into the driver elements for efficiency are: Performance indicators: Portfolio at Risk: Outstanding balance on arrears > 30 days + total gross outstanding refinanced (restructured) portfolio)/ Total outstanding gross portfolio Risk coverage ratio: Loan Loss Reserves/(outstanding balance on arrears over 30 days + refinanced loans) Write-off Ratio: Write-offs/Average Gross Portfolio Loans per Staff: Number of Loans/Total Staff Cost of Funds Ratio: Benchmark today in the industry (worldwide): The Best microfinance portfolios have PAR > 30 days of less than 3% with an average of 6% The best institutions with microfinance portfolios have at least 90% of Risk Coverage Ratio, however on average they have around 70% coverage The best institutions have 1% write-offs with an average range of 2-3% The best ratio for institutions with individual lending is 215 The cost of funds ratio reflects interest rates 4

5 Performance indicators: Interest and Fee expenses on Funding Liabilities/Average Funding liabilities Leverage: Total Liabilities/Total Equity Portfolio yield: Interest and Fee income/average Gross portfolio Client Retention Rate: (Number of borrowers at the end of the period number of new borrowers for the period)/number of borrowers at the beginning of period Benchmark today in the industry (worldwide): in the local markets The average debt/equity ratio for the best institutions with microfinance portfolios was 4 in 2000 Average portfolio yield for the sector in 2000 was 39.5% down from 41.5% in 1999 A normal retention rate should be over 80%. 4. An alternative requirement for recognition as Microcredit Institution, instead of efficiency analysis by the Technical Audit Unit, is to require a Rating or Assessment Report prepared by an independent agency of international prestige. These reports would usually have two parts: a) Adjustment of financial statements: to better reflect its situation at the light of prudent accounting principles. The most common s 3 and their impact is the following: Adjustment Effect on Financial Statements Type of Institution most affected by Adjustment Usually increases loan loss Institutions that have unrealistic provision expense on income loan loss provisioning policies statement and loan loss reserve on balance sheet 1. Loan loss reserve and provision expense 2. Write-off 3. Subsidized cost of funds On balance sheet reduces gross loan portfolio and loan loss reserve by an equal amount, so that neither net loan portfolio nor the income statement is affected. Lowers portfolio at risk indicator. Increases financial expense to the extent that the institution s liabilities carry a below-market Institutions that do not write off non-performing loans aggressively enough. Institutions with heavily subsidized loans 3 For a detailed discussion on methodologies of, consult The ACCION CAMEL ( 5

6 Adjustment Effect on Financial Statements Type of Institution most affected by Adjustment rate of interest. Decreases net income. 4. In-kind subsidy 5. Inflation 6. Reversal of interest income accrued on nonperforming loans Increases administrative expense to the extent that the institution is receiving subsidized goods or services. Decreases net income. Increases financial expense. May generate a reserve in the balance sheet s equity account, reflecting that portion of the institution s retained earnings that has been consumed by the effects of inflation. Decreases profitability and real retained earnings Reduces interest income and net profit on the income statement and equity on the balance sheet Institutions using goods or services for which they are not paying a market cost. Institution s funded more by equity than by liabilities will be hardest hit, especially in highinflation countries. Institutions that continue accruing income on delinquent loans past the point where collection becomes unlikely, or that fail to reverse previously accrued income on such loans. b) Rating or assessment of the institution: criteria and methodology vary widely among rating and assessment institutions. As a general rule, a rating or assessment in an above average category would be required for MCI recognition. 6

NATIONAL MICRO-FINANCE POLICY

THE UNITED REPUBLIC OF TANZANIA MINISTRY OF FINANCE NATIONAL MICRO-FINANCE POLICY MAY, 2000 PRINTED BY THE GOVERNMENT PRINTER DAR ES SALAAM-TANZANIA NA:TI:ONAL.'IVllCR:.O~ FINANCE POLICY 1.0 INTRODUCTION