Investors looking to put their money into microfinance face the daunting task of determining which institutions are most suitable for their investment objectives. Unlike traditional investments, there are few benchmarks and little commentary on the best-performing microfinance institutions (MFIs). A lack of transparency on the risk, financial and social performance, and management of MFIs presents a significant barrier for investors.
In this blog we will look at the Write Off Ratio and how it can contribute towards defining the overall quality of the portfolio.
Write Off Ratio
This indicator simply represents the loans that the institution has removed from its accounting records because of a substantial doubt that they will be recovered. Writing-off a loan is an accounting operation used to prevent the institution’s assets from being unrealistically inflated by loans that are unlikely to be recovered.
The process affects the gross loan portfolio and loan loss reserves equally. Therefore, unless provision reserves are inadequate, the transaction will not affect total assets, net loan portfolio, expenses or net income. Write-offs have no bearing whatsoever on collection efforts or on the client’s obligation to repay.
Write-offs should be viewed in conjunction with PAR to get an accurate assessment of portfolio quality. Write-off policies vary greatly between MFIs and countries for regulatory and tax reasons. Typically, loans in arrears for more than 90 days are seriously delinquent and have a high probability of not being collected. After 180 days, these loans are typically written-off; however, it remains up to the MFI’s discretion to determine when loans should be written off. It is generally good practice the write loans off at least once per year.
The Write-Off Ratio is commonly known as the Charge-Off Ratio in the traditional banking sector. It is used the same way as it is within microfinance, where the charge-off is the value of bad debt deemed to be uncollectable that is taken off of the accounting records.
It should be noted that regulatory authorities do not generally publish Write-off ratio data.
In the next blog we will be discussing Impairment Expense Ratio.