Question

Micro-finance operations face a number of problems with credit assessment, selling financial products, and controlling the loan book. Discuss these issues.

Answer 1

Just as the name suggests, micro-finance deals with financing activities at the micro level i.e. the unemployed or considerably low income individuals and businesses are supported by provided financial services, these are usually those people with insufficient collateral security to offer which makes it relatively difficult for them to approach a proper bank for loan. These micro-finance operations aims to provide aid to such classes of people and encourage their growth.

Now that we understand the kind of clientele such microfinancing businesses have, we can reasonably agree to the fact that not necessarily the people who are in need of this microfinance are well educated. These might be people with humble background and little education so it becomes very important to make them understand what are the financial products the microfinance firm has to offer and how those products work. They have to be educated about which product suits their purpose well and why. They have to be given basic understanding of money management. This here is one issue that needs to be effectively dealt with by conducting some tutorial or classes for clients of such business. Another extremely critical area is credit assessment. As mentioned above, microfinance seekers might not have adequate collateral to be given as security (so the loans here are collateral free loans),also since they are not eligible for obtaining any financial service from banks, there is no credit history of such clients available. This makes credit assessment of such individual/businesses extremely difficult. Credit Scoring has become popular in assessing the creditworthiness of such clients for such businesses. Loan book is basically book wherein details of all loans given by the microfinance business is maintained. For a microfinancing business, there is a little control on this loan book. It can control the disbursement of loans but it cannot control the repayments. Various metrics such as measuring the yield, etc gives an estimate about the quality of loan portfolio it is holding.