Group Lending

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					CHAPTER 3
Microfinance institutions offer their clients loans using specific lending technologies, or methodologies. These processes by which loans are delivered, aim to increase the value of the product to the client, while simultaneously decreasing the risk and the costs to the institution. MFIs have accumulated strong experience in various methodologies, and there are as many methodologies and adaptations as microcredit operations. Effective methodologies have three things in c ommon: they adhere to basic microlending principles, they adapt to fit the customers’ preferences and they are suited to the capabilities of the institution to manage the products and services. W e category loan methodology in to two types are group lending and individual lending. I. GROUP LENDING In group lending, groups of borrowers are involved in granting and recovering loans. Group lending does not usually involve a group loan, but rather loans to individuals who form a group as a guarantee. The group mechanism reduces the risks and costs associated with providing small loans to low-income persons who lack traditional collateral, business plans, business records, and/or credit histories. This is accomplished by transferring many of the administrative costs and credit risks to the clients themselves. Borrowers assume part or all of the responsibility for most facets of the lending process, including client selection, business assessment, repayment collection, and delinquency management. The three main variations on the group approach include village banking, group of groups, and solidarity groups. All three types of group lending employ a stepped loan approach whereby the loan size is linked to the number of loans the client has repaid. For example, new clients can receive a loan up to $100. If they repay that loan on time, they may borrow up to $150, and so on. This process gives clients an opportunity to develop a credit history with the lender without exposing the institution to a significant credit risk. Lenders employing this approach recognize that the loan amounts during the initial loan cycles do not usually meet clients’ needs, but this is considered necessary to teach clients how to use credit effectively and to demonstrate their creditworthiness.
Microcredit Methodology


1.1. VILLAGE BANK In the village banking model, the group serves as a financial intermediary. A group of thirty to fifty individuals form a village bank, which they manage themselves and therefore assume some of the administration costs. The village bank borrows from an external source, usually a support institution, and then on-lends to individual bank members. Borrowers repay the village bank in regular installments, and at the end of the loan term the village bank repays the support institution. The amount the village bank can borrow from the support institution generally depends on the amount of member savings it mobilizes. Member deposits form the foundation of the bank’s internal account, which serves as security for the loan from the support institution. The village bank can also use its internal account to meet additional demand for credit, from members as well as nonmembers, or to finance community development activities. Accumulated savings and income earned by the internal account may eventually capitalize an autonomous village bank. In this credit technology, a support institution usually plays a critical role in helping to form and train the members of the village bank, and provides access to external capital. In Cambodia, be used to launching village bank methodology during initially started Microfinance sector in early of 1990s by some institution such as Amret (formerly Ennatien Moulethan Tchonabat), Cambodia Rural Economic Development Initial Transferring (CREDIT MFI). These loan methodology were benchmark from Grameen Bank Bangladesh. 1.2. GROUP OF GROUPS The group of groups approach, used by Grameen Bank (Bangladesh), its replications, and others, relies on social pressure from a wide network to reduce credit risk. Typically, a self-selected group of five prospective borrowers are linked with four or five other groups from their village to form a center. Prospective borrowers initially go through several weeks of training or indoctrination, during which time group members begin to make small savings deposits. This weekly savings practice continues during the client’s relationship with the financial institution. Loans for incomegenerating activities are usually provided to individual. Group members on a staggered basis, initially to two of the five members. The group and the bank worker must approve their loan application. If this staggered format is used, after the first two
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members make weekly repayments for two months, two more members of the group are eligible for loans. The final member, usually the group leader, is eligible after they have made repayments for two months. If any member defaults, the whole group becomes ineligible to receive subsequent loans. While in most group of group approaches, members are not liable for the debts of a delinquent member, they often make payments for that member to maintain their own eligibility for future loans. The grouping of groups is designed to increase efficiency of managing very small loans and to increase the moral obligation for repayment. There are two primary differences between the village bank and group of groups approaches. First, in the Grameen model, there is always a bank worker in attendance at weekly meetings; in village banking, the participation of extension agent’s declines as the management capacity of the village bank grows. Second, there is no internal account in the Grameen model. All funds are disbursed and collected by bank workers, and therefore, the center does not have its own funds to manage. Savings generated by the c enter usually serve as security against default and may provide the institution with loan capital. AMK GROUP LENDING METHODOLOGY To be part of a group, the potential client needs to fulfill the following conditions: (1) must be willing to be part of a solidarity group and offer moral guarantee for each other; (ii) should have at least one economic activity in the household; (iii) no two members in one group can be from the same family or household; (iv) cannot have existing (outstanding) loans from other microfinance institutions, programs, banks or money lenders. There are no requirements for gender but women are encouraged to participate. Each group nominates a group leader who is in charge of ensuring member attendance to meetings, troubleshooting, and liaison with the village bank president, Credit Officers and other members. End of Term Village Installment Village Credit Line Village Bank Bank Bank Group members with Group members with Group members who seasonal (lumpy) regular cashflow have completed two cashflow cycles Social guarantee-No need for physical collateral or guarantors First Loan – US$50 First Loan – US$50 Max first loan – Max Ceiling – US$125 Max Ceiling – US$125 US$250 Max Ceiling – US$500 32


Loan guarantee Loan amounts

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Disbursement deadline Maximum term Repayment amount and frequency Prepayment penalties Late payment fee Other fees Loan-liked compulsory savings

1-2 weeks 12 months 3% monthly interest, end of term principal

1-2 weeks 24 months Monthly fixed principal, declining 2.8% interest No Additional 1% per month Up-front fee 0.5% of loan amount None

1-2 weeks 18 months 3% monthly interest on the outstanding loan; principal on the end of term No Additional 1% per month Up-front fee 0.5% of loan amount None

No Additional 1% per month Up-front fee 0.5% of loan amount None

1.3. SOLIDARITY GROUP In the solidarity group approach, 3 to 10 micro entrepreneurs form a group to coguarantee each other’s loan. Solidarity group lenders employ one of two legal means for transferring the credit risk to the group: either group liability, like the group of groups approach, in which the default of one member causes the other members to lose access to repeat loans; or joint and several liability, in which each group member is legally responsible for the debts of the other members. Since there are fewer members in a solidarity group than with the other two group approaches, and the community is less involved in the lending process, the solidarity methodology is appropriate in a wider range of settings, including urban and rural areas. The solidarity approach also tends to require less from clients in the form of weekly meetings, forced savings, or the maintenance of an internal account. PRASAC Solidarity group lending methodology. The group sizes are between 3-8 members. The organization has both male and female clients, there are mixed clients even within groups. The organization for starting its operation in any Province, first seeks PRASAC MFI Ltd permission from the Governor of the Province; the villages are then decided based on size, competition and economic potential. The permission is also sought from Commune chief and at the village level; the village chief becomes the first line of communication. The Credit officer (CO) informs village chief about PRASAC
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and its work and collects information about the village. The report is then prepared and submitted to the sub-branch and the branch manager who in turn verify the information. The CO then identifies individual clients and form solidarity groups. The members are made aware of PRASAC products and policies. The CO then invites loan applications and prepares loan documents, which are submitted, to the sub-branch and branch managers for verification of client details. Loans less than 3 million Riel (US$ 750) can be sanctioned by sub-branch manager, 3-15 million Riel (US$ 750 – 3,750) by branch manager and loans greater than 15 million Riel, only by the credit committee at the Head office. The credit committee comprises directors of all the departments, except internal audit. The loan decision is taken based on viability of the venture for which the loan is being taken and its financial projections. Lending is done only in the local currency Riel. While the group loans are disbursed and repayments are collected at village level, the individual loans are disbursed and repayments are collected only at branch and sub-branches. Only in case the branch and sub-branch are far from the village, the credit officer may collect repayments from individual borrowers as well. II. INDIVIDUAL LENDING There are two basic types of individual lending for business loans: the conventional commercial approach and individual microlending. These credit technologies are designed to minimize costs and risks, but for different markets. Conventional banking serves clients with assets, business records and plans, and credit histories, which can provide sufficient information to demonstrate that they are low-risk. Individual microlending targets low-income clients who are not likely to have documentation to indicate their risk level. Consequently, alternative means of managing credit risk are required. 2.1. CONVENTIONAL BANKING Conventional banking is usually document-and asset-based. Loan approval is based on available evidence, such as a firm’s balance sheet and business plan, as well as detailed business records. Banks collect a host of documents that provides them with information to assess risks. Loan analysis typically considers the 3 Cs of credit: Character, Capacity, and Collateral. Of these three areas, the emphasis for most commercial lending is on 1)capacity, which includes an analysis of industry,
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business, and financial risk, as well as a cash flow analysis to determine if


business can service the debt; and 2) collateral as a secondary repayment source and an indication of commitment. The character of the prospective borrower, based primarily on the applicant’s credit history, is also important. Loan approval tends to be a fairly expensive and time-consuming process as bank staffs evaluate the pile of required documentation. As a result, fewer, larger loans are a more efficient means for the bank to deploy its resources, as long as this does not result in excessive concentration of the portfolio in any one loan or related loans. A similar conclusion is reached from applicants: if they do not need a large loan, the costs of the application process are not worth the effort. There are two categories of conventional business clients: corporations and small businesses. With corporate lending, the loan is guaranteed by the company’s assets in one form or another. Where traditional banks are willing to serve the small business market, they usually lend to the entrepreneur as an individual and require that he or she provide personal assets as guarantees, even if the business is incorporated. This allows the bank to access collateral and secures a commitment with which it is more comfortable. With both the corporate and small business markets, clients typically consist of established commercial businesses with proper legal documentation. The bank wants properly licensed and registered customers because this allows the bank to use the legal system to enforce contracts. It also minimizes the risk of the client being subject to legal disruption. Since the market for this type of customer is competitive, interest rates are determined in part by what other financial institutions are charging. Some commercial banks are becoming extremely innovative to increase their share of the small-business market. They have developed credit scoring models based primarily on the applicant’s personal and business credit history. Bucking the conventional banking wisdom, these lenders are not particularly concerned about the capacity of the business and they may not even require collateral. For these innovative credit products, documentation may consist of a one-page application that can be faxed to a loan processing center. This product allows traditional banks to simplify the application process to provide fast loans. It also enables them to broach the market served by the microlenders, but with one caveat: applicants must have substantial and nearly impeccable credit histories.

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2.2. INDIVIDUAL MICROLENDING Individual microlending tailors conventional banking to the unique

characteristics of informal sector firms. This approach gathers information to assess risk, not by collecting documents, since they often do not exist, but through direct inspection of the enterprise and household and through recommendations of respected persons. Individual microlending also relies on the three Cs, but with a different emphasis. The primary factor is the individual’s character, followed closely by the capacity of the business and household to repay the loan. The character of a prospective borrower is assessed through interviews with neighbors, customers, suppliers, and community leaders. Loan assessments determine the cash flow of the entire family economic unit following the assumption that low-income households often have several sources of income as part of their survival and risk reduction strategy. The cash flow analysis does not usually take into account the impact of the borrowed funds on the earning potential of the household. Individual microlenders will take collateral when possible, but the security options are more expensive than with conventional banking. Individual microlenders often request cosigners to guarantee the loan, and may accept jewelry, productive assets from the business, and even household furniture and appliances as collateral. These forms of nontraditional collateral serve primarily to demonstrate the borrower’s commitment and are rarely used as a secondary repayment source. The conventional banking approach is not appropriate for small and micro entrepreneurs who typically do not have appropriate documents and assets, who cannot offer traditional collateral, who do not have proper legal documentation, who do not want large loan sizes, who need a fast and easy application process, and who lack credit histories. CREDIT MFI INDIVIDUAL LOAN PRODUCT It is a core loan product of CREDIT MFI (Cambodia), it represent up to 75% of loan portfolio. CREDIT offer individual loan for both local currencies (Riels currency) and US dollar currencies. This loan is target to client who has physical collateral such as land, building, fixed assets, productive assets, or inventory. The loan amount varies from KHR 200,000 or US$50 to KHR 40,000,000 or US$10,000, with a maximum length up to 24 months. The interest rate is charged at 2% to 3.2% per month, depending on the loan amount, type of currency and repayment location, by using a declining balance for calculating repayment schedule. Clients are offered the option to pay the loan by weekly, bi-weekly, 4-weekly and monthly and client can pay off their
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loan after 4 months repayment at any times without additional interest charged.

INSTITUTION     Economies of scale—a larger clientele served by a fixed investment in operating assets Economies of scope—increased capacity to deliver multiple services through the same group mechanism Mitigated information asymmetry through the group’s knowledge of individual borrowers Improved loan collection—better screening and selection through peer pressure and joint liability, especially if group penalties and incentives are incorporated in the loan terms   Costs and risks are transferred to clients Reduced moral hazard risks through group member monitoring and peer pressure CLIENT     Building block to broader social and business network Absence of individualized collateral substituted for by joint collateral Improved savings mobilization, especially if incentives are incorporated in a group scheme Assistance with repayments

INSTITUTION      Less effective in heterogeneous communities Difficult to enforce contracts May generate higher desertion rates than individual lending Reduced institutional learning of clients’ credit histories Departure of group leader may jeopardize group viability 37

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  

Covariance risk because of similar production activities Risk of generalized repayment problems (contagion) May be costly and time-consuming to form and maintain viable groups

CLIENT     Potential for corruption and control by a powerful nucleus or leader within the group Limited flexibility of loan product; loan may not meet client’s needs Potential free riders Costs and risks are transferred to clients

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