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1. Loan Portfolio Audit

Sustainability of an MFI depends on how good its portfolio quality is and is measured most commonly by the Portfolio at Risk (PAR) ratio. MFIs often operate in areas which lack basic infrastructure pertaining to payment systems and microfinance clients rarely have bank accounts. Also, microfinance operations are human intensive and MFIs are susceptible to the risk that the loan disbursed would not reach the intended clients. Some of the other factors which could negatively impact loan portfolio quality include

  1. Weak MIS and tracking system for overdues
  2. Involvement of unauthorized agents in portfolio creation process
  3. Weak Internal controls
  4. Poor product design
  5. Poorly trained staff
  6. Natural disasters and other exogenous factors.

 M2i’s loan portfolio audit is a comprehensive exercise that –

  • Assesses compliance between MFI’s stated credit policy and operations
  • Evaluates appropriateness of key policies related to the loan portfolio
  • Assesses quality of key management systems.
  • On a sample basis, cross-checks MFI records with those of clients, at the clients’ location
  • Checks accuracy of the internal reports generated by the MFI
  • Checks accuracy of the reports and documents submitted to the investors and the lenders
  • Confirms physical identity of the clients on a sample basis
  • Analyzes and reports the key risks that the MFI faces

2. Loan Portfolio Audit is useful for

Existing and potential lenders and investors who want to assess if the portfolio quality reported by the organization is correct. Loan Portfolio Audit also gives insights in to the risk factors which could potentially impact loan portfolio quality of the organization in the future.

MFI’s management, which wants to assess if there are any latent factors that could result in potential portfolio quality problems. Loan Portfolio Audit is also useful for an MFI which is facing portfolio quality problems and wants to understand factors which have caused these problems.

3.  Methodology

3.1 Sampling

A reasonably large sample, consisting of 500-1,000 clients in 5-10 branches of the MFI, is selected for client visits and verification of loan documents. A combination of stratified random sampling and judgmental sampling is used for sampling clients as well as the loan documents. Our sampling process ensures that the different categories of clients are adequately represented in our analysis. While we meet most of the clients in the group meetings, attempt is also made to meet some clients in their houses/workplaces.

3.2 Scope

M2i’s Loan Portfolio Audit covers the following aspects

Aspect

Description

Group/client visits

Group/client visit is an important component of Loan Portfolio Audit. Following aspects are checked

  1. Timeliness of group meetings
  2. Attendance in the meetings
  3. Adherence to specified procedures
  4. Verification of identity of clients
  5. Verification of documentation with the groups/clients
  6. Verification of loans balances

Verification of documents

Documents related to application, appraisal, disbursement and collection are verified for

  1. Completeness
  2. Accuracy
  3. Authentication

Evaluation of key processes

Following processes are evaluated for their appropriateness and compliance to policies

  1. Selection of areas and villages
  2. Group formation and training of clients
  3. Appraisal of loans
  4. Disbursement and collection

Evaluation of key systems

Following systems of the MFI are evaluated to see if these are capable of maintaining good portfolio quality with current and planned scale of operations.

  1. Accounting System and MIS
  2. Operational monitoring
  3. Internal Audit
  4. Human Resource Management
  5. Risk Management Systems

Verification of financial and MIS reports

Various reports produced by the management are verified for the following

  1. Completeness
  2. Timeliness
  3. Accuracy
  4. Consistency
  5. Usability

Trends and insights arising out of the reports are also analyzed.

4. Key findings of Loan Portfolio Audit

The following table presents an illustrative summary of what could be the key findings of a Loan Portfolio Audit exercise.

Finding

Possible causes

Portfolio quality of the organization is poor
  1. Weak MIS and tracking system
  2. Poorly designed products
  3. Inadequate control systems

Actual portfolio quality is significantly different from what is reported by the MFI.
  1. Systemic problems in the MIS
  2. Lack of understanding in the organisation about how to calculate portfolio quality ratios.
  3. Deliberate attempt by the management to hide delinquencies
  4. Refinancing and rescheduling of loans

Loans have been given to non-existent clients/groups
  1. Lack of Operational monitoring
  2. Inadequate Internal Audit

 

Unauthorized agents are involved in inductions of groups/clients, disbursement and collections
  1. Lack of operational monitoring
  2. Weak appraisal system
  3. Inadequate Internal Audit
  4. Flawed incentive system
  5. Poorly trained/corrupt staff

 

Loan sizes are beyond absorption capacity of clients
  1. Inadequate appraisal
  2. Competitive pressure

Clients are paying more interest/principal than what they are supposed to pay.
  1. Inadequate training of clients
  2. Weak MIS
  3. Corrupt staff

Accounting of principal/interest is incorrect
  1. Incorrect product design
  2. Poorly trained staff
  3. Weakness in the MIS and accounting system

 

Actual yield on portfolio is significantly different from the expected yield
  1. Poor portfolio quality
  2. Incorrect accounting
  3. Poor product design

There are differences in portfolio figures reported by the MIS and accounting system
  1. Frauds
  2. Weaknesses in accounting system and MIS
  3. Poorly trained staff

Totals of portfolio arrived at by adding individual balances does not tally with consolidated portfolio balances
  1. Frauds
  2. Weaknesses in accounting system and MIS
  3. Poorly trained staff

If a loan officer is absent, no collection takes place for his clients
  1. Poor MIS
  2. Poor operational monitoring
  3. Poorly trained and demotivated staff

The MFI is not providing reports to the lenders as required under the lending agreements.
  1. Lack of understanding and diligence on part of the management.
  2. Inadequacy of the MIS to generate reports required by the lenders.



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