Microfinance Institutions Rating

Introduction

Microfinance Institutions (MFIs) rating service is a professional assessment of MFI’s credit risk which is a function of a MFI’s exposure to business and financial risks as well as the likelihood of it receiving extraordinary financial support in case of distress. It is a forward-looking assessment of operational performance, financial performance and financial position, risk profile under both normal and stressed operating scenarios, strategy, market position, diversification, governance and management, as well as risk management practices. Effectively, the assessment focuses largely on the MFI’s capacity to honour its general obligations - deposits, borrowings and other liabilities in a timely manner.

Rating Criteria

Beacon Ratings uses a comprehensive rating tool consisting eight categories of indicators. Under each category are sub parameters to assess an MFI.

Operating environment

Economic environment: The dominance of the agriculture and services sector in the economic framework of Ghana define the broad economic framework for MFIs. This couple with large unbanked population particularly in these sectors provides significant business opportunities for MFIs.
Regulatory environment: The MFI regulatory environment is loosely regulated to create conducive and interactive framework for MFIs. The adherence to the regulatory framework by MFIs is assessed.

Systems and controls

History and track record: These are assessed using the following factors:

Number of years in existence
Geographical coverage
Number of clients
Number of branches
Portfolio size

Scalability and sustainability

Resources base sustainability: Fundraising strategies, current level of efficiency and profitability to test the sustainability level in case of large-scale operation and diversity.
Organizational sustainability: Ability to develop into a mainstream financial institution.
Program sustainability: Ability to sustain operations on a larger scale.

Documentation level

Extent of documentation in terms of manuals on MFI’s:

Products, policies, processes, and authorizations
Adherence to content of documentation

Management information system

The robustness of information management system in terms of mitigation of the technological risk, reliability, relevance and quality of information and reporting system are assessed.

Credit delivery system
Loan overdue monitoring system
Cash flow management system
Delinquency management system

Human resource management

Quality of human resource management and capacity of MFI to attract and retain professional staff are assessed:

Knowledge of staff on microfinance operations
Selection and recruitment process
Training need assessment and training arrangements
Accountability and responsibility of staff
Incentive scheme linked to performance of staff
Staff turnover ratio

Internal control and audit

Effectiveness of internal control systems, degree of formalization of processes, policies, procedures and effectiveness of internal audit are assessed:

Loan approval and disbursing processes
Segregation of duties
Control systems
Independent audit and scope
Internal audit efficiency

Regulatory compliance

Regulatory compliance builds reputation among lenders, donors and others regulators. Thus, extent of MFI compliance with banking laws, regulatory directives and circulars are evaluated.

Market share

Market share of MFI is determined in terms of the deposits mobilised by the MFI in comparison to total deposits mobilised by industry. This provide insight into the stability of liquidity for the MFI. It covers:

Core vs non-core deposits
Retail vs corporate deposits
Current accounts
Saving accounts

Asset quality

Asset quality refers primarily to credit quality of earning assets, which comprises loan portfolio and investment portfolio. Quality in terms of the degree to which loans are performing - paid back in accordance with their terms, and the likelihood that they will continue to perform. Asset quality is assessed using:

Loan portfolio to total assets
Loan portfolio concentration
Portfolio at risk - PAR30, PAR60, PAR90
Restructured loans
Write-off ratio against industry benchmarks
Provisions against delinquency
Non-performing assets/ total assets
Net non-performing assets/ net-worth
Non-performing loans and advances/ gross loans and advances
Non-performing loans and advances provision/non-performing loans and advances

Capital adequacy

Capital adequacy refers to sufficiency of equity capital and other related surpluses to cushion and absorb any shock that MFIs may experience as a result of losses or diminution of its assets. It includes retained earnings and reserves. An assessment of capital adequacy focuses on the capacity of MFI to absorb future credit losses arising from credit risk, market risk, liquidity risk and operational risks. The following indicators are assessed:

Conformance with regulatory capital requirement: Compliance with statutory requirement and ability to grow it in the future to meet business requirement.
Basel II & III, and prudential guidelines: Internal policy to conform with Basel II and III prudential guidelines and maintenance of capital to cushion probable losses beyond regulatory requirement.
Sustainability of capital adequacy: Adequacy of capital in relation to its growth plans, internal capital generation, risk appetite and interest rate sensitivity.
Quality of capital: Core Tier 1 capital - equity and Tier 2 - subordinated capital. Hidden reserves such as unrealised gains on investment book, assets revaluation surpluses, and other surpluses.
Solvency profile: Extent of net non-performing assets to net-worth. It measures the capital coverage of unprovided portion of non-performing assets.

Capital adequacy assessment factors include:

Equity to total assets
Equity to loan and advances
Risk weighted assets to total qualifying capital
Growth rate of internal capital generation
Profit retention ratio
Tier 1 capital to risk-weighted assets
Tier 1 and Tier 2 capital to risk-weighted assets

Funding and liquidity

Funding and liquidity assessment focus on the MFI’s ability to raise funds to overcome short-term difficulties.

Funding: Diversification of funding sources - local and international borrowed loans are assessed:

Demand and term deposits from the public
Adequacy of funding sources
Capacity to attract new funding

Liquidity: Sufficiency of liquidity is measured by the capacity of MFI to meet daily expenses and demand on deposit. On a longer-term basis, liquidity is measured by the degree to which core assets are funded with stable liabilities. The following factors are assessed:

Expected cash flow
Capacity to borrow from the market
Stock of high-quality liquid assets

Profitability and efficiency

Profitability: Strong earning capacity and high profitability of MFI helps build-up capital. Profitability is assessed using:

Operational self-sufficiency
Financial self-sufficiency
Return on assets
Return on equity

Efficiency: Sustainability of the MFI is assessed through operational efficiency and staff productivity. Typical measures include:

Portfolio yield
Cost-income ratio
Loan loss provision
Operational efficiency ratio

Management quality

Management quality measures the capacity of senior management to manage the business operations and associated risks efficiently.

Management stability
Adherence to business and financial plan
Management pro-activeness
Management experience and track record
Capability of the second layer of management
Management’s understanding of MFI business
Management’s appetite for risk and risk management

Corporate governance

Governance structure in terms of competence and track record in relation to MFIs governance are assessed. Key factors assessed include:

Board independence
Board composition
Board committees
Board oversight responsibilities
Transparency in reporting and disclosures
Board practices and support for management

MFIs rating scale and definitions

Rating Scale	Definition
AAA	Highest credit quality. MFI has an exceptionally strong capacity to meet its financial commitments and exhibits a high degree of resilience to adverse developments in the economy, and in business and other external conditions.
AA	Very high credit quality. MFI has a very strong capacity to meet its financial commitments, and is generally in a position to withstand adverse developments in the economy, and in business and other external conditions.
A	High credit quality. MFI has a strong capacity to meet its financial commitments but is somewhat more susceptible to adverse developments in the economy, and to business and other external conditions than institutions in higher-rated categories.
BBB	Good credit quality. MFI has adequate capacity to meet its financial commitments. While some shortcomings are apparent, the institution is generally in a position to resolve these within an acceptable timeframe.
BB	Moderate risk. MFI exhibits some obvious weaknesses in its operating practices and key financial indicators. The financial performance has typically fallen below peer group standards.
B	High credit risk. MFI exhibits fundamental weaknesses in its operating practices and key financial indicators.
CCC	Very high credit risk. MFI has several immediate problems of serious nature.
CC	MFI has a high risk of going into default.
C	MFI has very high risk of going into default.
D	MFI requires sustained external support without which its continued viability is in doubt. Defaults on its financial commitments have already occurred.

MFIs rating outlook

Rating outlook assesses the potential direction of MFI’s rating over the intermediate term, typically over a one financial year. Ratings from AA to B may be modified by a positive (+) or negative (-) suffix to show its relative standing within the major rating categories.
Positive	Indicates a rating may be raised
Negative	Indicates a rating may be lowered
Stable	Indicates a rating is likely to remain unchanged
Developing	Indicates a rating may be raised, lowered or remain unchanged