The first three types of credit risk control—product design, client screening and credit committees—are intended to prevent delinquency and eventual loan losses. However, it is unrealistic to plan on designing an ideal product and selecting ONLY the best clients in order to avoid loan delinquency. Some loans invariably become delinquent and loan losses will occur. To minimize such delinquency, CARE’s Economic Development Unit recommends the following six delinquency management methods:
1) Institutional Culture: A critical delinquency management method involves cultivating an institutional culture that embraces zero tolerance of arrears and immediate follow up on all late payments. MFIs can also remind clients who have had recent delinquency problems that their repayment day is approaching.
2) Client Orientation: A logical first step toward developing a zero-tolerance institutional culture is to communicate this concept to each new client before she receives a loan. An orientation curriculum should be prepared along with graphics and teaching aids to simply and clearly describe the terms of services being offered, the expectations of each client, and procedures that will be followed in the case of arrears.
3) Staff Incentives: Creating staff involvement in discouraging delinquency, through a staff incentives system, can be effective. Financial incentives entail minimum portfolio quality criteria for incentive eligibility and should have a greater weight for portfolio quality than for portfolio quantity. In addition, staff should carry bad debt in their portfolio for a significant period of time (at least six months) to ensure that they are held accountable for making credit decisions. Non-financial incentives include branch and loan officer competitions and special recognition for top performers.
4) Delinquency Penalties: Clients should be penalized for late payment. This could include delinquency fees pegged to the number of days late and limiting access to repeat loans based on repayment performance.
5) Enforcing Contracts: An MFI will quickly lose control of portfolio quality if it fails to enforce its contracts. MFIs should not have any policies in their contracts that they are not prepared to enforce. While certain accommodations can be made for borrowers who are willing but unable to repay, any uncooperative behavior from delinquent clients should quickly escalate to the most severe penalties that the MFI could enforce, including the use of the local judicial system if appropriate. Clients should be oriented to penalties and delinquency procedures before receiving their first loans, so they know exactly what to expect if their loans become delinquent.
6) Loan Rescheduling: Given the vulnerability of the target market, it is common for borrowers to be willing but unable to repay. After carefully determining that this is indeed the case (i.e., concluding that clients are not cleverly pulling on one’s heartstrings), it may be appropriate to reschedule a limited number of loans. Only done under extreme circumstances, this may involve extending the loan term and/or reducing the installment size. MFIs must be transparent about their rescheduling policies and they must report their portfolios accordingly. Portfolio quality indicators and provisioning requirements should clearly distinguish between regular and rescheduled loans.