Risk Management, Credit Appraisal and Recovery in Microfinance
Risk map
Microfinance faces credit risk, operational risk, liquidity risk, interest-rate and funding risk, regulatory risk, reputational risk and over-indebtedness risk. Multiple borrowing across MFIs, informal lenders and banks is a major credit risk. Cash collection, field staff fraud, data privacy and cyber risk are operational concerns. Because MFIs lend without collateral, appraisal and collection quality determine survival.
Credit appraisal
Assess the household, not just the borrower: all income sources, seasonality, existing debt, dependants and vulnerability. Verify KYC, purpose and residence; check credit bureau records; use group appraisal and field visits. Apply the RBI 50% rule: total monthly repayment obligations across all loans must not exceed half of monthly household income. Match instalment frequency to cash flow and keep a buffer for shocks.
Recovery and monitoring
Track collection efficiency, portfolio at risk (PAR) and early warning signals: missed instalments, repeated rescheduling, multiple lenders, business stress or migration. PAR>30 and PAR>60 are early indicators; an NPA is generally a loan overdue more than 90 days. Recovery must follow fair practices: reminders, counselling, restructuring and grievance redressal. Coercive collection, public shaming and unauthorised agent action create legal and reputational risk.
Worked example
A household earns ₹20,000 a month and already pays ₹4,000 in EMIs. Headroom under the 50% rule is ₹10,000 minus ₹4,000, equal to ₹6,000. A proposed EMI of ₹7,000 breaches the rule, even though the borrower's own shop income looks adequate. The lender should reduce the loan amount, extend tenure or wait until existing debt falls. If the household's income is seasonal, use a conservative annual average, not the peak month.
Traps
Do not compute the ratio on the borrower's income alone; it is household income. Do not ignore loans from other lenders. Do not call PAR>30 an NPA. Do not rely on collateral, which is prohibited for microfinance loans. Do not accept coercive recovery as normal.