A. Rationale for setting a rating system for MFIs


A rating system (RS) for categorizing the MFIs is required to be formulated considering their overall institutional strength with special focus given to the issues pertaining to sustainability in microcredit. This will help in assessing an MFIs ability to attract and use funds from external sources, especially from formal money market, as it is crucial for their long term sustainability. Moreover, this will also enable MFIs in developing their own institutional development plan, as their areas of weakness/strength will be clearly spelled out by this RS.

B. Sustainability issues in microcredit

The issues of sustainability in microcredit have several dimensions, which are interrelated and complimentary to each other as well. Three interrelated sustainability issues in microcredit are:

1. Microcredit borrower’s sustainability.
2. MFI’s financial and economic viability.
3. MFI’s institutional viability.

1. Microcredit borrower’s viability.

The foundation of the pyramid of a sustainable microcredit program is the viability of its clients i.e. the microcredit borrowers. Their inability to increase income in a sustained way for coming out of the poverty cycle as a result of participating in the program will lead to the collapse of the entire pyramid. Several direct/indirect indicators may be used to measure borrower’s viability. Increase in income, formation of income earning asset, changes in income portfolio, increased ability to manage larger amount of financial leverage; return on investment of borrowed money may be some of the direct indicators. Drop out rate, savings rate, loan recovery rate, income & occupational mobility, program’s effect on wages, and improvement in social indicators (e.g. Literacy rate, social awareness etc.) are examples of some of the indirect indicators.

2. Financial and economic viability of MFIs

(a) An MFI may be termed as financially sustainable if its operating income atleast equalizes with its operating expenditure. The cost of operations include cost of fund, cost of administering the program and loan loss provision. The indicators related to this issue will circle around quality of portfolio, cost of fund, efficiency in administering the program interms of productivity and rate of service charge/interest.

(b) Nevertheless, the long term viability depends on achieving economic viability. An MFI may be defined as economically viable if it can run its operation without enjoying any subsidy. The relevant indicators in this relation may be subsidy dependence index.

3. Institutional viability of MFIs

An MFIs institutional viability relates to its organizational capability of implementing its microcredit program on a sustained manner. The essential components of this organizational capability are well-institutionalized systems, adequate & appropriate policies in place geared to achieve its prime objective—poverty alleviation/eradication. The indicators related to this issue may be aimed at reflecting the status of MFI’s program placement, program implementation, governance(external & internal), HRD, Financial management and internal control system, institutional culture etc. Finally in order to be institutionally viable, an MFI must have an well-institutionalized management succession procedure.

C. Rating system: Setting the performance indicators in relation to the sustainability issues

PKSF, an apex financing institution for organizations involved in implementing microcredit programs, has developed a rating system to categorize its partner organizations (PO) with a view to evaluate their overall institutional strength in relation to the aforementioned sustainability issues. This rating system was thoroughly discussed and well accepted in a workshop attended by 126 POs of PKSF on February 23, 1998 at BARD, comilla.

General principles for using the weighted scoring system of rating/categorizing the partner organizations (POs) of PKSF are attached in annex-01 along with three enclosures.