Dep’t of Banking and Finance

CHAPTER FIVE
MICROFINANCE PERFORMANCES
6.1 Performance analysis
What is Performance Analysis?
A serious definition goes like this:
Performance analysis involves gathering formal and informal data to help customers and
sponsors define and achieve their goals. Performance analysis uncovers several
perspectives on a problem or opportunity, determining any and all drivers towards or
barriers to successful performance, and proposing a solution system based on what is
discovered.

A lighter definition is:

Performance analysis is the front end of the front end. It's what we do to figure out what to do.
Some synonyms are planning, scoping, auditing, and diagnostics.

What does a performance analyst do?

Here's a list of some of the things you may be doing as part of a performance analysis:

 Interviewing a sponsor
 Reading the annual report
 Chatting at lunch with a group of customer service representatives
 Reading the organization's policy on customer service, focusing particularly on the
recognition and incentive aspects
 Listening to audiotapes associates with customer service complaints
 Leading a focus group with supervisors
 Interviewing some randomly drawn representatives
 Reviewing the call log
 Reading an article in a professional journal on the subject of customer service
performance improvement
 Chatting at the supermarket with somebody who is a customer, who wants to tell
you about her experience with customer service

1
Dep’t of Banking and Finance

Core Performance Indicators for Microfinance

Experience has shown that funding agencies’ microfinance interventions produce better results
when design, reporting, and monitoring focus explicitly on key measures of performance.
Unfortunately, many projects fail to include such measurement. This note, written for staff who
design or monitor projects that fund microfinance institutions (MFIs), offers basic tools to measure
performance of microfinance institutions (MFIs) in five core areas:
1. Outreach—how many clients are being served?
2. Client poverty level—how poor are the clients?
3. Collection performance—how well is the MFI collecting its loans?
4. Financial sustainability—is the MFI profitable enough to maintain and expand its services
without continued injections of subsidized donor funds?
5. Efficiency— how well does the MFI control its administrative costs?

(Attachment A deals with indicators for community-managed revolving funds and other forms of
microcredit that do not pass through a formal MFI.)
The indicators suggested here do not capture all relevant aspects of MFI performance. Some
funders, and certainly all MFI managers, will want to monitor a longer list of indicators. And there
are important dimensions, such as governance quality, that simply cannot be quantified. The five
performance areas discussed here represent a minimum that should be
•treated in all project designs (reporting past performance of institutions that are
expected to participate, and insuring that systems are in place to measure these
indicators during the project)
• monitored and reported during implementation.
• included in all other appraisals or evaluations of existing institutions.

This list has been kept short, and the treatment of indicators as basic as possible, in order to make this
note useful for non-specialists. Attachment B suggests references—all of them available on the
internet—for readers who want more detail.
1
There is no single authoritative definition of “microfinance.” For purposes of this note, “microfinance” refers to any
project or component thereof that supports delivery of (1) very small, uncollateralized or less-than-normally-
collateralized loans, or (2) other financial services, such as savings or insurance, for low-income clients. For reporting
purposes, CGAP, the consortium of microfinance donors, counts loans as microfinance if their average outstanding
balance—see section 2 below—is not above US$5000 for Eastern Europe and NIS; $2000 for Latin America and the
Caribbean; $1500 for the Middle East, North Africa, global and other projects; and $1,000 for Sub-Saharan Africa,
Asia, and the Pacific. For savings services, an appropriate cut-off might be one third or one quarter of the loan
amounts.

2
Dep’t of Banking and Finance

1. Outreach
Indicator. The best measurement of outreach is straightforward: The number of clients or accounts
that are active at a given point in time
This indicator is more useful than the cumulative number of loans made or of clients served during
a period. Among other distortions, cumulative numbers make an MFI offering short-term loans
look better than one providing longer-term loans. The recommended measure counts active clients
rather than “members” in order to reflect actual service delivery: members may be inactive for
long periods of time, especially in financial cooperatives.

Interpretation. Expanding the number of clients being served is an ultimate goal of almost all
microfinance interventions. But rapid expansion sometimes proves to be unsustainable, especially
during an MFI’s early years when it needs to design its products and build its systems. It has very
seldom been useful for funders to pressure MFIs for rapid expansion.
2. Client poverty level
Indicator. Many, though not all, microfinance projects are expected to reach poor clients. There
are various techniques for measuring client poverty levels, some quite expensive and others
simpler, but as yet there is no widespread agreement on any one of them. If the project does not
use a more sophisticated indicator, it should at a minimum report the following rough proxy for the
poverty level of loan or savings clients at a point in time:

Avg. Outstanding Balance = Gross amount of loans or savings outstanding

Number of active clients or accounts

This point-of-time number should not be confused with total amounts loaned or deposited during
the reporting period, or with the average initial amount of loans in the portfolio. The Average
Outstanding Balance includes only loan amounts that clients have not yet repaid, or savings that the
clients have not withdrawn. For comparison purposes, it is useful to express this indicator as a
percentage of the host country’s per capita GDP (atlas method). An average outstanding loan balance
below 20% of per capita GDP or $US 150 is regarded by some as a rough indication that clients are
very poor.
Interpretation. Average Outstanding Balance is roughly related to client poverty, because better-off
clients tend to be uninterested in smaller loans. But the correlation between loan balances and poverty
is very far from precise. Low loan sizes do not guarantee a poor clientele. Likewise, growth in average
loan size does not necessarily mean that a MFI is suffering “mission drift.” As an MFI matures and
growth slows, a lower percentage of its clients are first-time borrowers, and average loan sizes will rise
even if there has been no shift in the market it is serving.
Funders who want to reach very poor clients should usually look for MFIs that are already committed
to a low-end clientele, rather than trying to encourage higher-end MFIs to change their

3
Dep’t of Banking and Finance

market. Most MFIs that focus on the very poor use formal tools to screen potential clients by income
level.
3. Collection performance
Reporting of loan collection is a minefield. Some indicators camouflage rather than clarify the true
situation. Moreover, terminology and calculation methods are not always consistent. Therefore,
whenever any measure of loan repayment, delinquency, default, or loss is reported, the numerator and
2
denominator of the ratio should be explained precisely.
MFIs’ self-reported collection performance often understates the extent of problems, usually because
of information system weaknesses rather than intent to deceive. Collection reporting should be
regarded as reliable only if it is verified by a competent independent party.
Indicators. The standard international measure of portfolio quality in banking is Portfolio at Risk
(PAR) beyond a specified number of days:

PAR (x days) = Outstanding principal balance of all loans past due more than x days
Outstanding principal balance of all loans

The number of days (x) used for this measurement varies. In microfinance, 30 days is a common
breakpoint. If the repayment schedule is other than monthly, then one repayment period (week,
fortnight, quarter) could be used as an alternative.
Many young or unsophisticated MFIs don’t yet have loan tracking systems strong enough to produce a
PAR figure. Most of these, however, should be able to calculate Loans at Risk (LAR), a simpler
indicator that counts the number of loans instead of their amounts. As long as repayment is roughly the
same for large loans and small loans, LAR will not differ much from PAR.

LAR(x days) = number of loans more than x days late

total number of outstanding loans

When an MFI “writes off” a loan, that loan disappears from the MFI’s books and therefore from the
PAR or LAR. Thus, it’s useful when reporting these measures to include a description of the MFI’s
write-off policy. (For instance, “the MFI doesn’t write off loans,” or “the MFI writes off loan amounts
that remain unpaid more than 6 months after the final loan payment was originally due.”)
2
For a list of issues that need to be clarified when interpreting measures of collection, see [CGAP Financial Disclosure
Guidelines, no ___]

4
Dep’t of Banking and Finance

An alternative measure, the Current Recovery Rate (CRR), can be computed by most MFIs, and gives
a good picture of repayment performance—but only if it is interpreted very carefully.

CRR = cash collected during the period from borrowers

cash falling due for the first time during the period under the terms
of the original loan contract

This ratio can be calculated using principal payments only, or principal plus interest.
CRR and variants of it are often misunderstood. It is tempting, but badly mistaken, to think of the CRR
as a complement of an annual loan loss rate. For instance, if the MFI reports a 95% collection rate, one
might assume that its annual loan losses are 5% of its portfolio. In fact, if an MFI making 3-month
loans with weekly payments has a 95% collection rate, it will lose well over a third of its portfolio
3
every year. Thus, the CRR indicator should never be used without translating it into an Annual Loan-
loss Rate (ALR). Here is a simplified formula:

ALR = 1 – CRR x 2
T
where T is average loan term expressed in years
Variations in late payments and prepayments cause the Current Recovery Rate to jump around over
short periods, often registering above 100 percent. Thus, it must be applied to a period long enough to
smooth out random or seasonal variations—typically a year.
Interpretation. Repayment of an MFI’s loans is a crucial indicator of performance. Poor collection of
microloans is almost always traceable to management and systems weaknesses.
The strongest repayment incentive for uncollateralized microloans is not probably not peer pressure,
but rather the client’s desire to preserve her future access to a loan service she finds very useful to her
and her family: thus, healthy repayment rates are a strong signal that the loans are of real value to the
clients. Finally, high delinquency makes financial sustainability impossible. As a rough rule of thumb
when dealing with uncollateralized loans, Portfolio or Loans at Risk (30 days or one payment period)
above 10%, or Annual Loan-Loss Rates above 5%, must be reduced quickly or they will spin out of
control .
4. Financial Sustainability (Profitability)
Indicators. In banks and other commercial institutions, the commonest measures of profitability are
Return on Equity (ROE), which measures the returns produced for the owners, and Return on Assets
(ROA), which reflects that organization’s ability to use its assets productively.
3
See the CGAP paper on delinquency measurement cited at the end of this Note for an explanation of this surprising
result, and for calculation refinements.

5
Dep’t of Banking and Finance

ROE = After-tax profits

Starting (or period-average) equitY 4
ROA = After-tax profits
Starting (or period-average) assets
These are appropriate indicators for unsubsidized institutions. But donor interventions more
typically deal with institutions that receive substantial subsidies, most often in the form of grants or
loans at below-market interest rates. In such cases, the critical question is whether the institution will
be able to maintain itself and grow when continuing subsidies are no longer available. To determine
this, normal financial information must be “adjusted” to reflect the impact of the present subsidies.
Three subsidy-adjusted indicators are in common use: Financial Self-sufficiency (FSS), Adjusted
Return on Assets (AROA), and the Subsidy Dependence Index (SDI). These measures are more
complex than the indicators discussed previously, and there are slight variations in the ways of
calculating each of them.
FSS and AROA use similar adjustments.
An Inflation Adjustment (IA) reflects the loss of real value of an MFI’s net monetary assets due to
inflation:
5
IA = (Assets that are denominated in currency amounts
minus Liabilities that are denominated in currency amounts)
times The inflation rate for the period.
This adjustment is usually based on net asset values at the beginning of the period, but using period
averages may be appropriate for MFIs that receive large grants, or other infusions of equity capital,
during the period.
A subsidized-Cost-of-Funds Adjustment (CFA) compensates for the effect of soft loans to the MFI:
CFA = Period-average borrowings by the MFI
times “Market” interest rate
minus Actual amount of interest paid by the MFI during the period
A common benchmark for a market interest rate is the rate that commercial banks pay on 90-day fixed
deposits. Arguably a more appropriate rate is a few points above the “prime” rate that banks charge on
6
loans to their best customers, because few MFIs could actually borrow at a lower rate.
4
ROE calculations should use starting equity unless there has been a substantial infusion of new equity from an
outside source during the reporting period.
5
For instance cash, investments, or loans; but not buildings or equipment
6
A more sophisticated benchmark would be based on the probable cost (including interest, administrative expense,
and reserve requirements) of the specific form(s) of commercial funding the MFIs is likely to be raising when it moves
beyond soft funding sources.

6
Dep’t of Banking and Finance

The In-kind Subsidy Adjustment (ISA) quantifies the benefit an MFI gets when it receives goods or
services without paying a market price for them (computers or free services of a manager are common
examples).
ISA = Market price an unsubsidized MFI would pay for a good or service
minus Actual price paid by the MFI
Financial Self-Sufficiency (FSS) is a subsidy-adjusted indicator often used by donor-funded
microfinance NGOs. It measures the extent to which an MFI’s business revenue—mainly interest
received—covers the MFI’s adjusted costs. If the FSS is below 100%, then the MFI has not yet
achieved financial break-even.
FSS = Business revenue (excluding grants)
Total expenses + IA + CFA + ISA
Adjusted Return on Assets measures an MFI’s net profit or loss (including adjustments) in relation to
the MFI’s total assets.
AROA = Accounting profit/loss (excluding grants) – IA – CFA – ISA
Period-average total assets
5. Efficiency
Indicators: The most commonly used indicator of efficiency expresses non-financial expenses as a
percentage of the gross loan portfolio:
Operating Expense Ratio = Personnel and administrative expense
8
Period-average gross loan portfolio
8
“Gross” loan portfolio means the total outstanding (not yet repaid) amounts of all loans. For an MFI that provides
voluntary savings, average total assets could be used as the denominator. This ratio is sometimes called
“Administrative Expense Ratio” or simply “Efficiency Ratio.”

7
Dep’t of Banking and Finance

The Operating Expense Ratio is the most widely used indicator of efficiency, but its substantial
drawback is that it will make an MFI making small loans look worse than an MFI making large loans,
even if both are efficiently managed. Thus, a preferable alternative is a ratio that is based on clients
served, not amounts loaned:
Cost per Client = Personnel and administrative expense
Period-average number of active borrowers [ x GNI per capita]
If one wishes to benchmark an MFI’s Cost per Client against similar MFIs in other countries, the ratio
should be expressed as a percentage of per capita Gross National Income (which is used as a rough
proxy for local labor costs).
Interpretation. Measured in terms of costs as a percentage of amounts on loan, tiny loans are more
expensive to make than large loans. Only a few extremely efficient MFIs have an Operating Expense
Ratio (OER) below 10 percent; commercial banks making larger loans usually have OERs well below
9
5 percent. The average OER of MFIs reporting to The Micro Banking Bulletin is about 30 percent,
which probably reflects considerable inefficiency.
As mentioned earlier, the OER tilts the scales against MFIs making smaller loans: six $50 loans cost
more to make than one $300 loan. Measured this way, an MFI can become more “efficient” by simply
dropping its smaller borrowers, even without making any improvements in operatings systems. Cost
per Client avoids this perverse result.
When a microfinance market starts to mature and MFIs have to compete for clients, price competition
on interest rates will usually push the MFIs to get more efficient. But many MFIs face little real
competition. External monitoring of efficiency is especially important in those cases.
Young or fast-growing MFIs will look less efficient by either of these measures, because those MFIs
are paying for staff, infrastructure, and overhead that are not yet fully used.
In a nutshell:
At a minimum, measure in five areas:
1. Outreach
--number of active clients or accounts
2. Client poverty level
--Average outstanding balance per client or account
3. Collection performance
--Portfolio at Risk (PAR) or
--Loans at Risk (LAR) or
--Current Recovery Rate (CRR) together with
Annual Loan-loss Rate (ALR)
4. Financial sustainability (profitability)
for commercial institutions:
--Return on Assets (ROA) or
--Return on Equity (ROE)
for subsidized institutions:
--Financial Self-Sufficiency (FSS) or
--Adjusted Return on Assets (AROA)
5. Efficiency
--Operating Expense Ratio (OER) or
--Cost per Client