Analysis of Microfinance Lending and Credit Assessment Methodology

depth psychology of microfinance Lending and acknowledgement Assessment methodological analysisMicrofinance Institutions (MFIs) core activities be driven by a genial burster through provision of full range of brinking needs to poor people for productionive purposes, thitherby contributing to the developmentl objective of poverty reduction. MFIs products and services includes micro- ascribe, micro-savings, micro-insurance and also remittances. Micro credence course is providing monetary capital to the poor household in order to engage them in income generating activities for alleviating poverty mostly to finance tiny businesses agricultural bestows. Typically this slip of lending is not secured by any substantiative but granted base on the clients ability to generate the necessary financial means for repayment found on his or her business activities. Most of the terms and conditions for micro attribute loans atomic number 18 flexible and easy to understand. However, th ere is no standard lending and realization sound judgment methodological analysis employed by MFIs. We are motivated to explore and document this research gap.1.2 The Innovation and Development of Microfinance Industry in MalaysiaThe provision of microcredit is nothing overbold in Malaysia. Poverty eradication political platforms involve provision of credit at subsidised rate to the poor has been around since 1970s after formation of the raw(a) Economic Policy (NEP) that was instituted in 1970. The earlier micro credit program was mainly carried out by credit unions, co-operatives, specialised credit institutions and NGOs. The provision of miserable financing designated mostly to finance micro enterprises, agriculture sector for poverty reduction and to improve income of the Bumiputera. The legislation for microfinance regulation in Malaysia includes, Moneylender Act 2002, canting and financial Institution Act 1989, Development Financial Institution Act 2002, and Cooperativ es Societies Act 1993, (Zakiah, 2004). The Microfinance business pretenses are based on mass market, cooperatives, monoline and distributor network (BNM, 2010).Majlis Amamah Rakyat (MARA), a council of trust to the Bumiputera and doctrine Guarantee Corporation (CGC) are some of the pioneers to introduce micro credit to micro enterprises. The rural credit institutions comprising of Agriculture confide of Malaysia (Agrobank), Farmers shaping Authority (LLP), Federal Land Development Authority (FELDA), Rubber Industry Smallholders Development Authority (RISDA) and other agro-based Co-operative Societies provide micro credit for the agriculture sectors. there are also a number of non-governmental organizations (NGOs) that engage in micro credit provision (Kasim and Jayasooria, 1993). These include Amanah Ikhtiar Malaysia (AIM), Yayasan Usaha Maju (YUM) and Sabah Credit Corporation (SCC) in Sabah, Koperasi Kredit Rakyat (KKR) in Selangor. Tabung Ekonomi Kumpulan Usaha Niaga (TEKUN) is a government agency micro credit provider. While, Malaysian Islamic Economic Development Foundation (YaPEIM), a cooperatives institution providing Islamic microcredit program based on al-rahnu concept in Malaysia.Prior to 2003, Commercial banks involvement in microfinance program are just limited to extending lines of credit to AIM, and as a mediator for schemes such(prenominal) as the loan fund for hawkers and petty traders operated by the Credit Guarantee Corporation (CGC). In May 2003, the government launched a Micro Credit Scheme, in particular stimulating agricultural production activities as well as expanding small and medium enterprise activities. Two banking institutions namely Agrobank and Bank Simpanan Nasional (BSN), and AIM fuddle been disposed(p) the responsibility to act out the scheme. The scheme is related free, and borrowers are eligible for a maximum loan of up to RM20,000 with interest rates charged at 4% per annum on reducing balance.The government acknow ledged that development of the microfinance industry is crucial in promoting greater financial inclusion, given that almost 80 percentage of the SMEs in Malaysia are micro enterprises (BNM, 2006). Thus, in August 2006, the National SME Development Council (NSDC) approved a comprehensive microfinance institutional framework proposed by BNM, comprising banking institutions, Development finance Institutions (DFIs) and credit cooperatives to develop a sustainable microfinance industry. This commercially-driven microfinance industry will complement the existing Government-sponsored microfinance programmes. This is important to ensure that micro enterprises have adequate and continuous admission fee to financing.Following this initiative, 10 local banks are now offering microfinance products providing a channel for micro enterprises to obtain financing from the stately financial systems. BSN was mandated to provide microfinance, composition Bank Rakyat would provide microfinance to me mbers of cooperatives and Agrobank would continue to provide microfinance to micro enterprises in the agriculture and agro-based sector. Banking institutions with their extensive nationwide network of branches would ensure wider outreach of microfinance. In addition, BNM proposed the establishment of the Malaysia Cooperative Societies rush to strengthen the role of credit cooperatives in providing credit to micro enterprises. The new comprehensive microfinance indusry framework in Malaysia is as isllustrated in accede 1 below. put back 1 The Microfinance Institutions (MFIs) in MalaysiaNon-Bank MFIsBank MFIsAmanah Ikhtiar Malaysia (AIM)Yayasan Usaha Maju (YUM)Koperasi Kredit Rakyat (KKR)Kooperasi Kredit Pekerja (KKP)Partners in Enterprise Malaysia (PiEM)Tabung Ekonomi Kumpulan Usaha Niaga (TEKUN)Council of Trust to Bumiputera (MARA)Malaysian Building Society Berhad (MBSB)Sabah Credit Corporation (SCC)Agrobank Bhd (AgroBank)Bank Kerjasama Rakyat Bhd (Bank Rakyat)Bank Simpanan Nasion al (BSN)Alliance Bank Bhd (Alliance Bank)AMBank Bhd (AM Bank)CIMB Bank Bhd (CIMB)EONCAP Islamic Bank Bhd (EON Bank)Public Bank Bhd (PBB)United Overseas Bank Bhd (UOB)Credit Guarantee Corporation Bhd (CGC)Source adapted from Jasman et. al., (2010)These financial institutions have adopted different business pretendings and strategies that leverage on the institutional strengths and niches to supports the credit needs of micro enterprises. A number of financial institutions have adopted a mass market model whereby the financial institution provides micro credit products through its existing branch network. Others, like Bank Rakyat, have adopted a cooperative model which provides microfi nance to its members. Some have employed the distributor network model, which leverages on the distributive capabilities of strategic business partners. Another is the monoline model with a dedicated microfinance operation, formed with its own distinct branding and processes designed to crotchetyly ap peal to micro enterprises.Table 2 Comparative Analysis of Non-Bank Microcredit syllabuss in Malaysia familyNon-Government Organization (NGOs)Government festerncyCoopeativesInstitutionAIMYUMTEKUNMARASCCYaPEIM guide GroupLow income communityBumiputra micro entrepreneursBumiputra mincroentrepreneursAgroculture based entrepreneursPretty tradersGold financingPrograme NameIkhtiar MicrocreditGeneral 1 2 and Group Fund addTekun MicrocreditBusiness financeCommunity Loan SchemeAl-Rahnu Micro CreditAge Limit18 geezerhood aboveWomen 18 to 55 years18 60 years21 60 yearsLoan centreMin NilMax RM20,000Min RM100Max RM20,000Min NilMax RM50,000Min 1,000Max RM10,000Min 1,000Max RM10,000Up to RM25,000Loan expiration6 months to 3 years6 months to 5 years6 months to 5 yearsUp to 4 yearsUp to 3 years affect Period21 eldN/a35 days11 daysN/aRepayment Period periodicalDaily, monthlyMonthlyMonthlyMonthlyMonthlyInterest Rate / Charge10%p.a4% 11%p.a5% 6%p.a1.25%p.m10%p.a0.1% 0.75%Program SupportsInsurance Business TrainingBusiness Training, Compulsory DepositsBusiness trainingCompulsory savingsAdvisory Business Matchingloan scheme for chemical throng of 5 or 6 individuals.Source UNDP(2008), and Respective Institutions websites. Note No published info available for KKR, KKP and PiEM microfiance program details.Table 3 Comparative Analysis of Banks Financial Institutions Microcredit Programs in MalaysiaCategoryBanking Instititions (BIs)Development Financial Institutions (DFIs)InstitutionABBAMBankCIMBEONCAPiPBBUOBCGCAgrobankBSNBank RakyatProgram NamePersonal FinancingAmMikroCash ExpressPersonal FinancingPB Micro FinanceEasiCashDAGSModal Usahawan 1BSN Teman NiagaMikro-iTarget GroupMicro enterprisesMicro enterprisesMicro enterprisesMicro enterprisesMicro enterprisesMicro enterprisesSMEsMicro enterprisesMicro enterprisesMicro enterprisesAge Limit25 60 years18 60 years21 60 yearsRetired civil servants25 60 years21 55 years21 60 years21 60 years18 65 yearsLoa n nitty-grittyRM2,000 RM50,000RM3,000 RM50,000RM3,000 RM50,000RM5,000 RM50,000RM3,000 RM50,000RM5,000 RM50,000RM50,000 RM3.0MRM1,000 RM50,000RM5,000 RM50,000RM1,000 RM50,000Loan Period6 months 5 years1 5 years6 months 5 years3 15 years1 5 years2 5 years3 months 5 years1 5 years1 months 5 yearsProcessing Period2 days5 days2 days5 days6 days7 days4 days6 days10 daysRepayment PeriodMonthlyMonthlyMonthlyMonthlyMonthlyMonthlyMonthlyMonthlyMonthlyInterest Rate / Charge5.05%p.a2.5%p.m2% 3%p.m2% 3%p.m0.9%p.m0.5% 3.5%p.a4%p.a4%p.a4%p.aSource Comparative table on microfinanc product features (BNM, 2010) and Respective Insritutions website1.3 Problem Statements Research issues in MicrocreditLending combines the science of obtaining and analysing the facts of a loan request and the art of making judicial decisions about that information, the feasibility of the business, and the credibility of the borrower. experience lenders focus on the key business issues quickly, me nd what information is needed, and then make prompt decisions based on that information. Developing sound credit judgement takes time and experience development lending to small businesses by the book is difficult and rarely results in a quality loan portfolio.There is no formula for determining creditworthiness. The loan officer must assemble and evaluate information and then determine what the entire picture looks like. tralatitious bank lenders preserve to the Four Cs of lending Credit, Capacity, Collateral, and Character. Development lending uses the same rigorous credit assessment principles, but applies them to situations in which the lender must rely on borrower character and cash flow from the business. The loan application and the first meeting with the borrower are the first screen of whether a business is a potential outlook for microcredit. Beginning with the first meeting, the lender must evaluate the quality of the business deal, the fit with the borrowers experienc e and capacity, and whether the financing amount and structure is appropriate.1.4 Research Questions/ObjectivesThe questions/objectives of this study areRQ1 To investigate the microcredit lending methodology of commercial-driven and government funded MFIsRQ2 To investigate the credit assessment methodology of commercial-driven and government funded MFIsRQ3 Is there any different mingled with lending and credit assessment methodology of commercial-driven and government funded MFIs?1.5 Significance of this studyThis paper aim to understand, comparatively analyze and document the MFIs lending and credit application assessment methodology of both the commercial-driven and government-funded MFIs microcredit program. This study will contribute to enrich the existing literature related to microcredit and microenterprises financing with specific reference to Malaysia environment.1.6 LimitationsSurvey involving only selected active MFIs based in west Malaysia. This paper only focused on mi crocredit lending and credit assessment methodology for micro enterprises only.1.7 Organization of ReportThis paper is nonionic into four parts, after the introduction, part two contains the literature review related to microfinance lending and credit assessment methodology for micro enterprises. Part three describing data collection and analysis methodology and the last part contains concluding remarks and recommendations.LITERATURE REVIEW2.1 Review of Microfinance Deli genuinely Methodologies (REFINE)The Review of Rural Finance Innovations in Asia-Pacific role have identified and documented the microfinance methodologies used in Asia. These methodologies include Grameen Bank Association for Social Advancement (ASA) SHG Linkage Banking Unit Desas (Village Banks) of the Bank Rakyat Indonesia (BRI) and Mixed model and mingled method (Sourcexxx)Grameen Bank model The Grameen model is the most popular and widely replicated model in Asia. It consistently achieves outreach both in d epth and order of magnitude and high repayment rates (98 per cent). The early replicators as early as 1989 were India, Malaysia and the Philippines others include China and Indonesia. The model focuses on poor peoples access to credit, with women as a priority small loans repaid in weekly instalments eligibility for higher loan amount for succeeding loans loans for income-generating activities financing activities chosen by borrowers themselves and forming solidarity groups. Over time, the replicators modified the model to type local contexts.ASA model ASA is another model from Bangladesh. In the 1990s, ASA gained recognition for achieving a repayment rate of 99 per cent. In Asia, the model has been replicated in India, Indonesia and the Philippines. While loan products are the same as with the Grameen model, the difference is that it does not impose the group co-liability. The model also requires that the borrowers form groups of 25 to 30 members. The model uses a unique standard ized branch approach which enables cost savings and efficiency in service delivery the branch has no need for additional personnel for rend and accountant, enabling it to fully cover costs even after 9 to12 months.SHG Linkage Banking model The SHG Linkage Banking model is an outcome of the Regional Linkage Banking create by mental act which is an initiative supported by APRACA and Deutsche Gesellschaft fr Technische Zusammenarbeit (GTZ) in the early 1990s. Using this model, NABARD of India achieved the largest scale and outreach in the countries supported by this programme. The approach is linking SHGs with banking institutions for loan and bewilder services. Most SHGs are formed by NGOs or government agencies with financial support from NABARD. One difference between this model and the Grameen and ASA models is that before obtaining their first loan, the members of SHGs are required to mobilize savings first. They usually start at a 11 or 21 loan- to-savings ratio, increasing to 41 in succeeding loan cycles. Bank loans are wholesaled to SHGs, which in turn lend to individual members following terms and policies set by the SHGs themselves. The SHG is the dominant microfinance methodology in India (Sinha, 2003).Unit Desas model Unit Desas are village banks of the Bank Rakyat Indonesia (BRI). The bank provides loans for any income-generating activity from 3 to 24 months for working capital and 36 months for investment capital. The reported repayment rate is 99 per cent. Charging market interest rates enabled the unit banks to be profitable and operationally self-sustainable units.Mixed model and tangled method As a result of cross-dissemination of various methodologies and experimentation by microfinance institutions, there is an emerging trend of adopting a mixed model and a mixed method. The former combines features of two or more models under one approach. The latter uses different methodologies for different client segments. For example, in the Phili ppines, microfinance institutions use an approach called GraSa which identifies clients and forms groups using the Grameen model while removing the co-liability requirement, which is a feature of the ASA model.Overall, the common thread among the best practices is the shift from mere credit to providing broader and sustainable financial services. While there are variations, there is an increasing emphasis on attaining a sustainable fund base, cost recovery of invested funds and efficient and responsive financial services to rural clients.2.2 Traditional Approach of Creditworthiness Assessment for Small BorrowersAn important role of credit markets is to screen borrowers and allocate credit efficiently based on their creditworthiness. Traditionally, banks have played a dominant role in doing so. One of the reasons posited for this has been that banks have the financial expertise to effectively intermediate capital (Diamond, 1994). The theoretical and empirical literature has argued th at banks do very little screening for small borrowers and rely excessively on collateral. In addition, recent theoretical literature has also highlighted that the screening role may be better performed by markets with many participants, as opposed to banks (Boot and Thakor, 1997). Alternative peer-to-peer credit markets have recently started gaining popularity in lending to smaller borrowers such as individuals and small firms, both in developed and developing economies (Rajkamal I., et. al., 2009)While prior research has provided substantial evidence of elevated default risk among lower-income, minority, and little creditworthy borrowers (see, for example, Avery et al., 1996, Deng, Quigley, and forefront Order, 1996, Berkovec et al., 1998, Pennington-Cross and Nichols, 2000), recent studies also suggest offsets to those risks via the slower prepayment speeds of targeted borrower groups (see, for example, Kelly, 1995, Van Order and Zorn, 2002, Archer, Ling, and McGill, 2002).Table 1 Summary of Criteria considered important by Bankers in Assessing Small Business Borrower Loan ApplicationsAssessment CriteriaAuthor(s)/YearCountryOwners Personal CharatcteristicsBusiness Ability(Fertuck, 1982)Honesty(Fertuck, 1982)Trading Experience(Deakins Hussain, 1994 Fletcher, 1995)Managerial Experience(Jones, 1982 Memon, 1984)Credit History(Jones, 1982 Memon, 1984)Quality of precaution(Rosli, 1995)Malaysialeverage and Security PositionGearing(Deakins Hussain, 1994 Fletcher, 1995 Berry, Grant and Jarvis, 2001 Binks and Ennew, 1996)Collateral(Ulrich Arlow, 1981)Guarantee(Deakins Hussain, 1994 Fletcher, 1995)Risk of Default(Rosli, 1995)MalaysiaOwners and Business FinancialsInitial Capial(Jones, 1982 Memon, 1984)Financial Strengths(Fertuck, 1982)Bank Lending PoliciesBank Policy(Berger and Udell, 2002)Relationship(Berger and Udell, 2002)SummaryTable 2 Negative Factors Resulting in Rejection of Small Business Loans ApplicationAssessment CriteriaAuthor(s)/YearCountryOwners Personal Charatcteristics wishing of Competecnce(Buttner Rosen, 1992 Desmond, 1991)Lack of Management Skills(Buttner Rosen, 1992)Lack of Entrepreneurial Skills Experience(Buttner Rosen, 1992 Desmond, 1991)Owners and Business FinancialsPoor Cash Flows(Struck Glassman, 1983)Poor Earnings Records(Fertuck, 1982) substandard Turnover(Read, 1998)Poor Credit RatingsLeverage PositionsPoor Collateral(Fertuck, 1982)Insufficient Owners Equity(Struck Glassman, 1983)Past Due in Credit(Struck Glassman, 1983)Excessive Loan Requests(Desmond, 1991)Gearing too high(Desmond, 1991)Business PlansInsufficient Market Research(Buttner Rosen, 1992)Incomplete Business Plans(Buttner Rosen, 1992)Other FactorsBad Timing(Buttner Rosen, 1992)Summary2.3 Innovation in Small Business Lending The Art and erudition of MicrocreditThe history of microcredit program can be traced back since 18th century where Credit Coperatives and charities provided small entrepreneurs in Europe (Hollis et. al., 1998). According to Hollis et. Al., a notable microcredit program in europe includes a fund created by Jonathan Swift, a novelist and the Irish Reproductive Loan Fund Institution.In developing economies, it is argued that among others absence of access to credit is presumed to be the cause for the failure of the poor to come out of poverty. Meeting the gap between demand and supply of credit in the formal financial institutions frontier has been challenging (Von Pischke, 1991). In fact, the gap is not aroused merely because of shortage of loan-able fund to the poor rather it arise because it is costly for the formal financial institutions to lend to the poor. Lending to the poor involves high transaction cost and risks associated with information asymmetries and moral hazards (Stiglitz and Weiss, 1981). Nevertheless, in several developing economies governments have intervened, through introduction of microfinance institutions to understate the gap then allow the poor access credits through provision of so called microcredit.Microcredit is defined simply as small-scale credit, most typically for less-advantaged individuals. In practice, microcredit is most frequently used to refer to credit provided specifically for the purpose of starting a small business and there is other microcredit products cater for other consumption needs of poor individual. The various forms of micro-credit systems have proven successful in delivering credit to the poor and ensuring high rate of repayment when compared to the formal channels. Because micro-credit systems have been effective in reaching the poor, many developing countries have set up special financial institutions that either directly provide credit to SHGs and the facilitating NGOs or help refinance commercial and cooperative banks that provide the credit. These national micro-finance institutions are in turn funded by international agencies as well as the national government (source xxxx)Microfinance Lending MethodologyMicro-lending methodology in practice is appearently different to mainstream banking. The distinguish characteristics are as follows (i) non traditional creditworthiness assessment criteria (ii) non traditional collateral accepted (iii) loan officers are not necessarily bankers (iv) credit is provided along with business support services. Other distinguishing features between them are as tabulated belowTable 3 Comparison of Micro-finance and Formal Banking Lending to Micro EnterprisesCharacteristicsMicrofinanceFormal BankingSize of loanSmall/tiny size of creditMedium/large creditDuration of loanShort durationMedium and longThriftEmphasis on thrift as well as loansFocus on loan onlyScreening and MonitoringGroup formation and informal methodsFormal ProceduresEnforcement of RepaymentsStepped or sequential loans, Peer pressure and weekly repaymentsCollateral and legitimate pressured for repaymentsNature of OrganizationSocial organizational formCommercial organization formMotivationSelf-help motivatedProfit motiva tedOutreachAccess to poor without collateral (all members)Access limitedLending MethodCash-flows based lendingAsset-based lendingAnalysisField visitsDesk AnalysisCredit AdministrationFlexible and personalized regulateSource Adapted with midification fromxxx2.3.2 Microfinance Loan Assessment and Credit Analysis MethodologyAn important function of credit markets is to screen borrowers and allocate credit efficiently based on borrowers creditworthiness (Iyer, et. al., 2009). The credit analysis is defined as a process of establishing the current creditworthiness of loan applicants and forecasting the trends in its development. Top priority goals and stages in the bank credit analysis are determined. (Feschijan, 2008). The analysis of the creditworthiness involves preliminary study of the factors and prerequisites which can affect adversely the duly repayment of the credit. When analyzing creditworthiness, along with the required prerequisites for creditworthiness it is necessary to car ry out a comprehensive study of the factors that determine it. It is believed that creditworthiness depends on several major factors the borrowers efficiency, his reputation, his capacity for profit making, the value of his assets, the state of the economic situation, his profitability, etc. In order to conduct a thorough study of the above mentioned, it is necessary to use a number of indicators for the credit analysis (Feschijan, 2008).Table 3 trial-and-error Evidence of Microcredit Repayment DeterminantsDeterminant factorsAuthor(s)/YearCountryRegular monitoring, audits, high repayment frequency, having group savings depositsDeininger and Liu (2009)IndiaClose monitoring and close relationshp with borrowersRoslan et. Al. (2007)MalaysiaThreats of sanctions, borrower incur less transactions costsBhatt and Tang (2002)USAGender of the borrower, type of business activity, amount of loan, repayment period and trainningRosalan and M. Zaini (2009)MalaysiaJoint liability, dinamic and progr essive lending, Peer monitoring, social ties and social connections, self-selection, income shocks, social sanction and cooperation, loan size, infrastructure and local economic environment, group rules and regulations, group size, age of the group, assistance offered by bank, gender, local culture, group homogeneity, role of group leaderBakshi (2008)N/a (literature review)Group gender decomposition (group with more females)Anthony and Horne (2003)USARESEARCH METHODOLOGYData Specification and Collection MethodTarget RespondentsTarget respondents will comprises of the following selected microfinance institutions (MFIs) which constitutes both the non-bank MFIs and bank-MFIsCategoryNon-Bank MFIsBank-MFIsOrganizationMARAYUMAIMTEKUNSCCBSNAgroBankBank RakyatTarget RespondentsCredit Manager/OfficerCredit Manager/OfficerCredit Manager/OfficerCredit Manager/OfficerCredit Manager/OfficerCredit Manager/OfficerCredit Manager/OfficerCredit Manager/OfficerNo. of Respondents4040404040404040 union respondents = 320A personally administrated survey was employed in this study. Target respondents were comprises of credit managers and officers of the above selected MFIs in west Malaysia.Questionnaire DesignTable 3.1 The Structured Questionnaire Design prickCategoryRemarksSection ARespondent ProfileThis section is designed to cater information on respondents demographic profile.Section BLending MethodologyThis section concentrates on profiling the lending methodology of MFIsSection CCredit AssessmentThis section is designed to explore microcredit assessment criteria employed by MFIsData Analysis MethodsDescriptive Statistics AnalysisDescriptive statistics analysis used to explore the characteristics of the respondents.Factor AnalysisFactor analysis use to analyse and determine the significant important factors for microlenders in analysing microenterprises loan applications.Analysis of Variance (ANOVA)ANOVA is used to established statistical significant of differences of lending a nd credit assessment methodologies between commercially-driven and government-funded MFIs.ANALYSIS AND DISCUSSIONSDescriptive Statistics AnalysisRespondent demographic factorsFactor AnalysisRQ1 To investigate the microcredit lending methodology of commercial-driven and government funded MFIsRQ2 To investigate the credit assessment methodology of commercial-driven and government funded MFIs