Managing recoveries for informal income earning borrowers
The African Union for Housing Finance and the Centre for Affordable Housing Finance in Africa , co-hosted a two day workshop, from 27- 28 March, in partnership with AUHF member, Central Africa Building Society , Housing Development Finance Corporation and the Zimbabwe Association for Housing Finance under the theme of “Managing recoveries for informal income earning borrowers”. The first series held in 2018 under the theme of “Lending to borrowers with informal incomes” had the objective of providing the participants with concepts, principles and tools for underwriting households with informal incomes, so they can partake in the housing finance market. The programmes are intended to enable participants to respond to the challenges and opportunities within the context of their local economies, while supporting better engagement between the public and private sectors.
According to International Labour Organisation (ILO), more than 61 percent of the global employed population make an income through the informal economy. In Africa, it is indicated that 85 percent of employment is informal. The Centre for Global Development argues that the informal sector will remain resilient as there is evidence of ‘gig employment’ growth in Africa. What African governments and private sector will need to resolve for, is finding ways of getting the informal sector to gain from improved efficiencies and digital platforms that can assist with productivity growth. At the same time, create a progressive inclusion and accommodation of the informal economy into the formal economy to generate value. The recognition of the informal market by financial institutions as a potential client for the growth of their market share could aid the advancement of available risk management techniques. HDFC has achieved this by designing market appropriate engagements methodologies. To date they have disbursed Rs. 8856,34 bn (USD 136 million) and have written off Rs.350million (USD 5,3 million). In a reflection on the first series, it was identified that there is a need for an enabling environment (political, regulatory, fiscal) in order to mitigate housing microfinance challenges in Africa. The factors that were emphasised involved:
- Access to Bankable Land and upgrading of infrastructure
- Lack of affordable capital for the microfinance lenders; which also leads to high on lending pricing.
- Institutional capacity whereby the available data is not utilised to its best use for more market product development and engagement with clients.
- Absence of market data tracking and segmenting the existing market needs that need to design the right financing responses.
- The need to educate borrowers on housing microfinance, savings and lending processes and the need for financial institutions to adopt segmentation and customer approach for the poor as they are not a homogenous group.
- The primary basis for evaluating loan applications in microfinance is character and repayment capacity rather than collateral.
Risk managing for Microfinance Institutions
In retrospect, the main thread that could be drawn from the presentations and discussions that formed part of the overview on risk managing for microfinance institutions revolved around the necessity for innovation by financial institutions. In order to cater for and reach the informal sector, it was deliberated that there is a need for innovation in practise by focusing efforts on understanding low income clients through the use of ‘alternative’ data. Use of alternative data such understanding of different types of movable asset ownership in the household, other income sources and intervals of receipt. Mobile phone companies have also leaped into the lending space, by making use of the data collected from their users.
Understanding the ‘client’ in order to deliver the right product
Microfinance institutions are increasingly interested in finding ways to mitigate the perceived risk of lending to borrowers with informal incomes. There is an underlying need for increased market research by banks in low income areas in order to understand the low-income client. This would potentially lead to the formulation of credit policies by banks that are targeted at the different income tiers of clients and considers the need to develop products that are context specific for the informal sector.
The discussions on credit risk were important in providing an alternative viewpoint to the commonly held assumption that credit risk is the inability of the borrower to pay their loan back to the bank. Alternatively, it was explained that the occurrence of loan defaults is also as a result of financial institutions providing the wrong products to low income clients. Importantly, there is a need to characterise different clients earning irregular incomes by profession in order to develop responsive financial products. As a result, having the right product for the low-income client is key to mitigating credit risk and that product development should undergo a rigorous process of testing, tweaking and then piloting to ensure the efficacy of the product.
A key point relating to product development which was discussed, is that there is a need for a paradigm shift in the traditional business model of banks that have departments operating in silos in developing a product. It was noted that in developing a microfinance product, it is vital to have the different management teams that comprise a bank collaboratively working from the start in order to deliver to the informal sector. One of the lessons to be drawn about the HDFC product offerings is that assessment is based on alternate documents and field investigation rather than traditional appraisal methods. Through assessed income appraisal, HDFC seeks to provide organised solutions to the informal sector, micro entrepreneurs, lower and middle-income households. The figure below shows the characterisation of clients and target segments.
Furthermore, the HDFC Customer Risk Assessment seeks to:
- Understand a customer’s stability through interviews with clients and neighbours to understand habits and home visits to applicants to understand their housing situation and stability
- Understand a customer’s source of income by visiting applicant’s business to observe daily business flows and costs. To understand the applicant’s business model and fluctuations in income.
- Standardisation by building a database of informal sector customers’ income by profession in different localities.
In summary, it was learnt through the discussions on understanding the low-income client that through a strong foundation of customer risk assessment, banks are better positioned to improve customers to be better clients to mitigate credit defaults.
How can banks make customers better clients in order to mitigate credit defaults?
This discussion focused on the need for micro finance institutions to educate clients about credit management which would significantly reduce the risk of loan defaults. More specifically, it was noted that the education should teach the client about various product offerings and the consequences of defaults. This education foundation forms the basis from which a borrower can make an informed decision – whether to borrow or not. Building on this argument, it was further indicated that the benefits of undertaking face to face teaching far outweighs digital education through online platforms. Microfinance institutions are in a better position to understand the low-income client’s needs and formulating of strategies of improved client offering through face to face engagements as this method encourages trust relationships to develop between the microfinance institution and low-income client.
The importance of credit risk management system in the business for early detection of likely client payment behaviour to implement risk controls
Learning from the Indian context, credit risk management systems are important as they act as an audit mechanism of the credit evaluation system, facilitates borrowing on better terms and increases sources of funding from capital investors. It was recognised that in order to begin catering for low income clients, the credit assessment and scoring system needs to be adapted to consider the profiles of different clients. Similarly, the discussion on Credit Reference Bureaus prompted responses on the quality of data and its importance for ensuring that lenders make faster and more accurate credit decisions which potentially reduces risk. One improvement to be noted, is the need for Credit Reference Bureaus to develop strategies to go down market and tap into the informal sector or their impact on ensuring accurate credit decisions are taken by lenders would remain limited.
Financial institutions were keen to gain knowledge of how financial institutions providing microfinance can begin to price risk into the loan covenants with the informal borrowers. From the Indian context, it was learnt that one of the ways in which financial institutions attract risk is through parameters of credit scores. It was suggested through the discussions, that it would be beneficial for financial institutions not to be bound by parameters of credit scores but rather offer different interest rates and loan terms to different income clients through the usage of risk-based pricing technologies and underwriting procedures – some which include face-to-face field work whereby the final decision is taken by human intervention on the viability of the information presented to the lender.
Assessing thin file clients and recovery methods for borrowers with informal incomes: Introducing the SMART Campaign
As with the previous discussion on pricing risk, another topic of interest was how to perform risk assessment for thin file clients? It was highlighted that alternative data is vital in ensuring the ability of financial institutions to be able to perform risk assessment. Alternative data depends on how well the financial institution knows the customer which correlates to the need for innovation in thinking to collect alternative data. Alternative data was defined to be the non-traditional information that can be collected about a client such as for example, movable assets that are held by low income clients. One of the more innovative ways to collect alternative data to be discussed during the session is through the Smart Campaign.
The Smart Campaign is a global effort to unite financial leaders around a common goal which is to keep clients as the driving force of the industry. The Smart Campaign is founded on the belief that financial service providers and their customers benefit when low income clients can access financial services with confidence. The Campaign seeks to unite microfinance providers worldwide to adhere to standards for the appropriate treatment of low-income clients through the Client Protection Self-Assessment tool. This improves the relationship between the microfinance provider and low-income clients which enables microfinance providers to better understand the needs of their clients.
Mitigating Credit Risk: Joint Liability, Non-Performing Loans and technological advancements in debt recovery
Joint Liability as a security for default was identified as a good mitigator of risk however it may also run the risk of increasing disharmony as the measure shifts the burden of repaying loans onto external parties. Debt recovery methods were identified to have advanced through the use of mobile phones to repay loans and this was illustrated through the example of M-Pesa which is a mobile phone-based financing and microfinancing service which initially launched in Kenya and Tanzania.
Learning from the Indian context, HDFC utilises a Client Relationship Management (CRM) tool which comprises different modes of communication at different stages of customer engagement, based on the propensity of default. These modes include call centre calls, sms, letters and emails and field visits from the contact centre, field team and legal team. One of the lessons to be drawn about the HDFC model is the importance of internal communication between departments in the microfinance institution and constant communication between the microfinance institution and low-income client which provides a foundation for education of borrowers before lending takes place .
The topic on non-performing loans stimulated a variety of discussions during the two-day workshop. It was deliberated that one of the ways in which to monitor NPLs for rehabilitation to recoverable debt, would be through reducing loan instalment periods, restructuring and recharging the payment period on a case by case basis. In one of the interactive discussions between the speakers and members was that one of the ways in which financial institutions can reduce the risk of NPLs is through Mortgage Guarantee Companies and Insurance Companies. Similarly, group loan products were identified to be a way in which micro finance institutions mitigate risk however it was warned that there are prerequisite steps of understanding the individuals that form part of these groups as the success of the product relies on the cohesiveness of the groups.
Site Visit: NBS Affordable Housing Project in Dzivarasekwa, Zimbabwe
One of the main components of the two-day workshop included a site visit to an affordable housing project in the predominantly working-class suburb of Dzivarasekwa, which is in the west of Harare, Zimbabwe. National Building Society (NBS) presented an overview of the project which commenced in 2017 and is expected to finish in 2019. The project is a partnership between NBS and institutional investors (National Social Security Authority) and the targeted beneficiaries are civil servants, who are also the pension fund beneficiaries.
NSSA has invested USD17 million towards the construction of 600 homes in Dzivarasekwa, ranging from one room to four rooms. The debt to burden ratio has been calculated at 40 percent in order to allow the civil servants to qualify for the loan. The different types of houses are priced as below:
- A one bedroom house is being priced at USD 17 341
- Two-room bedroom house is priced at USD 31000
- Three room bedroom houses are priced at USD 34300 and
- Four room houses are priced at USD 38000
The lessons that can be drawn from the AUHF professional development course are fourfold. Firstly, quality data (qualitative and quantitative) is important for microfinance institutions to be able to reach and target various segments of low-income clients and that understanding the socio-economic context of low-income clients is vital to be able to manage risk. Secondly, by understanding the low-income client’s needs, microfinance institutions are better placed to educate low-income clients through face to face engagements to enhance their financial literacy. Thirdly, there is a need to acquire ‘alternative’ data or non-traditional information about clients and one of the more innovative ways is through the ‘Smart Campaign’. Fourthly, the importance of internal communication between departments in microfinance institutions and constant communication between the microfinance institution and low-income client provides a foundation for early response mechanisms that mitigate credit risk.
 Smart Campaign 2019. https://www.smartcampaign.org/