LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT Loan Loss

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT Loan Loss Allowances • There are several reasons for having loan loss provisions and reserves: • Maintaining loans on the books that are unlikely to be repaid overstates the portfolio size

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT Loan Loss Allowances (cont. . ) • "A well - defined policy that establishes a loan loss reserve and periodically declares loans nonrecoverable saves a program from declaring a large amount unrecoverable all at once and thereby drastically reducing as assets".

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT Loan Loss Allowances (cont. . ) • Having past due loans that are non-recoverable (still in the books) has a negative compact on repayment rates. • Therefore, MFIs should have clear allowances for loan losses.

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT Loan Loss Allowances (cont. . ) • In fact, for each year, based on an aging analysis for loans, the allowance amount must be calculated. This is the loan loss provision. This equals or adds to the reserve. • There must be a good MIS which provides an aging schedule of all loans including past due loans, as given in the Portfolio Report

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT Loan Loss Allowances (cont. . ) • Sometimes, as in the beginning of an MFIs operations, it may not be possible to have an aging schedule, as loans may still not have become due. • In such circumstances,

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT Loan Loss Allowances (cont. . ) • when having an aging analysis is rather not applicable or not possible (due to the lack of data), • using the internationally recommended norm of 3% of loans outstanding as the allowance is appropriate and should be implemented.

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT • A loan loss provision is the amount shown on the Income and Expenses Statement. • Loan losses or write-offs occur only as an accounting entry. They do not mean that loan recovery should not pursued. In fact, it should be identified. They decrease the reserve and the outstanding portfolio.

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT • The same can be done with individual reserve rates, which are nothing but the probability or risk that loans in different categories will not be repaid (or collected from the clients). • Obviously, such a risk is almost absent in loans that are current – i. e. , they have no overdue. Therefore, the reserve rate is listed as 0%.

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT • The reserve rates increase as loans have been overdue for a longer period – the farther a loan is from the originally scheduled repayment, the likelihood or probability of the loan being repaid (or recovered) is lower. • Therefore, as the age of the loan, in terms of its overdue status increases, the reserve rate (or risk factor) also increases.

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT 4) International best practices recommend values for various categories of loans (as given in Box below) INTERNATIONALLY RECOMMENDED BEST PRACTICES NORMS FOR RESERVE RATES Status of Loans Reserve Rate % Current 0% 1 -30 days past due 10% 31 -60 days past due 25% 61 -90 days past due 50% 91 -180 days past due 75% 181 -365 days past due 90% > 365 days past due 100%

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT • • Loan Loss Reserve at Period Beginning + (PLUS) Loan Loss Provision for Period - (MINUS) Loan Write-offs during period =(equal) Loan Loss Reserve at end of period.

LOAN LOSS ALLOWANCES FOR DELINQUENCY MANAGEMENT • Two other general comments are in order here: • While no PAR is considered safe, good institutions generally have a PAR of between 57% for running loans, of which, a maximum of 23% could be actual loan losses • Such institutions, after a long period of similar and consistent PAR trends, sometimes, apply a 23% reserve rate for calculating the provision (rather than use the aging schedule of loans).