Microfinance Practice: RE: [MFP] Understanding default rates in MFI's group loans and Village Savings and Loans Associations

Dear Richard. Things are now very different.

The average outstanding loan size in a VSLA is $45, and disbursed is about $60-70. But it varies enormously. I have just returned from a VSLA today in southern Tanzania where one member just paid back a loan of $750, and capitalisation was over $5,000 - and I know of one in Nairobi with a capitalisation of over $500,000. But that's an outlier, and for most rural VSLAs loans are over 3 months and interest rates (determined by the members) vary from 5% per month to 10% per month. Since VSLAs have virtually no expenses and very high repayment rates, all of this income is net and untaxed. The average annualised return on assets is 29% (as per the 172,000 groups whose data is posted to the SAVIX – www.thesavix.org). 5% per month flat is an effective rate of 60% per annum (since there are no hidden fees or compulsory, blocked savings) so I am not sure where the figure of 500% comes from. The reasons that VSLAs have very high repayment rates are, I think:

1 they can only borrow a maximum of 3 times what they have saved

2 members are sensitive to the fact that they are borrowing their neighbours' money and are therefore a mite more prudent and accountable

3 members get all of their capital back at the end of a year, with interest distributed in proportion to savings. If a borrower defaults, shares equal in value to their debt are cancelled and earnings on those shares are lost to the defaulter

Most VSLAs are great for short-term needs/opportunities, such as low-investment petty trade, where the velocity of cash revolving in the IGA may be many hundreds of percent a month and daily returns are usually in the order of 5-20%. They are not so well-suited to agriculture, where maturities of investments are usually 4-6 months or longer and they are completely unsuited for long-term investment in fixed assets. So Chuck is right. Small short-term investments in informal trade tend to have very high yields, against which a 5-10% monthly cost of borrowing is a marginal and minor expense, whereas a longer-term investment usually yields less in percentage terms but more in absolute value and is accompanied with a lower cost of borrowing.

From: Chuck Waterfield [mailto:waterfield@microfin.com]
Sent: 29 June 2015 18:52
To: MFP
Cc: Hugh Allen
Subject: Re: [MFP] Understanding default rates in MFI's group loans and Village Savings and Loans Associations

Hello Richard,

In comparing prices, it is essential to evaluate them relative to the amount of the loan and the duration of the loan. Let's look first at conventional loans, then microfinance loans, then VSLA loans:

* A loan to buy a house, of $100,000 for 30 years can be good at 5% APR, but bankrupt you if it costs 10% APR

* A loan of $10,000 for a year at 10% might be a good decision.

* A microfinance loan of $1,000 for a year at 120% APR is very likely a bad decision.

* A microfinance loan of $1,000 for a month at 10% for that month (i.e., 120% APR) can be a good decision.

* A microfinance loan of $1,000 for four months at an APR of 120% probably isn't a good decision…. and then to accept the MFI's invitation to borrow that SAME amount at that SAME price for another four months, and then another four months, is very likely a bad decision.

The benefit-cost analysis from the point of view of the client shows that there may be quick, super-high returns, justifying a high price of a short loan. But few of the world's poor can generate super-high returns month after month, year after year. But many MFIs charge them super-high prices for those loans month after month, year after year. (Here are prices in your country right now, and many MFIs are charging over 100%: http://www.mftransparency.org/microfinance-pricing/Malawi/ )

A woman might turn $10 into $20 in a week, so if she sees that opportunity and doesn't have $10, she can borrow it for 10% a *week* and it is a smart decision. But the poor do not turn $1,000 into $2,000 in a week, nor in a month, and only some can do that in a year. The rational price to pay drops as amounts go up and time gets longer.

And that brings us to VSLA loans. VSLA loans are incredibly small amounts. Generally less than $10 in my understanding, in most countries. And they are extremely short-term loans, often just a week, in my understanding. My direct experience is quite old, dating back to the 1990's, when Hugh and I stumbled across this methodology in Niger. The amounts and terms likely are somewhat higher in various instances now. BUT… I'm sure VSLA loans are still vastly smaller than any loan an MFI provides, and VSLA terms are much shorter term than nearly any loan an MFI provides. That means paying prices of 500% for $10 for a week can be a smart decision for some people, some time.

I'm sure bad decisions are still made, and others can give data on repayment rates, but much of the same logic applies to defaults: If my house burns down and I didn't have insurance, I can't pay back the $100,000 loan. I lost a very large asset. But if my loan is for $10, I buy some bananas, and my bananas fall off the truck, I can probably find a way to pay back the $10 soon. But if I wait six months to pay back the $10, it has now become a loan of $100 and I'll probably default, at least on some of the interest payments.

Our common failing is to not fully see how to evaluate loan prices. APRs are a unit price - the price to borrow $1.00 for 1 year. That is a necessary means for us to calculate prices. But then to determine if that APR is a responsible price means to evaluate the APR in the context of amount and duration. MFTransparency will be publishing some articles on this essential topic in July.

Regards,

Chuck Waterfield
waterfield@microfin.com

"A lie too often told becomes the truth" - Lenin

On Jun 29, 2015, at 4:22 AM, richard chongo rigochongo@yahoo.co.uk [MicrofinancePractice] <MicrofinancePractice@yahoogroups.com> wrote:

Dear all,

Last week as I worked with NGOs working with VSLAs linking them to micro-finance banks, a thought crossed my mind on how these VSLAs manage their loans.

I have noticed that the interest rates for loans that members charge each other is very high, maybe between 200% and 500% higher, than the rates that MFIs charge. However, my rough sight shows that the repayment rate in VSLAs is far much better than in group lending in MFIs.

Is there any research or information that analyses the default rates in VSLAs in comparison to MFIs group lending? I would love to see if my assumption is correct and what issues surround the better repayment record in VSLAs. Is it because the VSLA members are motivated that it is their money they are growing and they will share the funds at the end of the period?

Best regards,

Richard Chongo
Social Performance Manager
Opportunity Bank Malawi