Microfinance credit risk management in low trust environment (1)

In business, they say, there are no sentiments. Business, they also say, should not be mixed with pleasure as the two are governed by different principles. Business decisions are usually cold, calculated and impersonal, especially where systems and structures are set up and functioning. These sayings seem to give the impression that nobody should be trusted. On the other hand, no business transaction can take place among people who do not trust each other. Trust is the bedrock of all business transactions, but behind this façade of trust as the basis of all business relationships is the reality: trust but verify every fact. In other words, trust cannot exist in a vacuum. It must be based on tangible and verifiable facts.

One of the major social problems of today is that we live in a world where reality is closely mimicked by fiction; truth is cloned by untruth and nobody knows who to believe. It is now so hard to know what is real and what is make believe. This has brought dislocation into many relationships, especially the relationship between the government and the governed. At least in Africa, and especially in Nigeria, the biggest lies are told by those that are supposed to command the most trust and respect – governments and, strangely, certain categories of religious institutions. And this is not peculiar to Nigeria. In some countries, presidents are telling lies openly; not through their spokesmen but directly by themselves.  People just tell lies as a matter of course; so routinely and often for no personal gains. Or how else do we explain the fact that people get routinely and deliberately misdirected by those they ask for direction on the streets of Lagos. Just ask them for the direction to a street, probably just around the corner, and see how for some strange reason, you are pointed to a direction that has nothing to do with the location of what you ask.

A few years ago, in the midst of failed public utilities and frustrating leadership outcomes, a research carried out by a reputable international media group returned a strange verdict that made the whole world chuckle – Nigerians emerged the happiest people on earth. Some tried to impugn the research procedure and methodology but many others linked the outcome to the prevalence of a culture of lies and untruths, laced with religious idiosyncrasies that encourage people to pronounce the opposite of every negative thing they feel or face. They must say they are strong when they are very weak; that they are rich when they are sorely poor, and such. The reason is that many have been taught, rightly too, that the power of life and death are on the tongue and what you say is what you become.  Researchers are beginning to have problems deciphering what respondents actually feel? This phenomenon may further complicate our data paucity challenge, and make research outcomes unreliable.

The global economic condition of today has negatively impacted the fortunes of many businesses. It has actually brought many corporations to the fringes of their trade. Some have moved from being market leaders to marginal businesses or fringe players. Naturally, such negative turn of events bring consequences that have industry-wide implications. For financial services providers, like banks and even nonbank credit service providers, such implications begin as heightened credit risk and the impairment of the loan book. This is bad enough challenge that gets worse in an environment in which truth, trust and integrity are exceptions and a rarity. They amplify credit risk that operators must address.

The fact that people are no longer tightly bound by their words has increased the risk of loan loss faced by lenders. It has become inescapable for lending institutions to find new and better ways of dealing with credit risk. Nigeria is just coming out of a recession and the tendency is for many companies to wear the look of prosperity while in reality they are in deep financial difficulty. There is hardly any sector of the economy that did not feel the impact of our recent economic contraction. We shall therefore do well to discuss some time-tested strategies for effectively managing credit risk, especially post-recession and for microfinance institutions.

We begin with a look at factors that affect the credit risk faced by lenders. These can be divided into four categories, namely: Operational, Products, Human Resources and the External Environment. Under operational factors, the first is poor credit selection. Because things are not always what they seem, lenders must be careful to avoid adverse selection. Every lending organization is supposed, and they often do, have Target Market Definition (TMD) and Risk Acceptance Criteria (RAC) for all transactions. These are the set of conditions a client must meet before the lender could enlist it as a potential beneficiary of its services. If these conditions are religiously followed, there is sure to be minimal credit difficulties. Poor quality clients would most likely be weeded off. But the problem is not with developing and implementing a TMD or RAC. It is with having the discipline required to effectively implement the criteria.

Many lenders with sound TMD and RAC suffer loan losses due to the absence of a system that ensures implementation is done impersonally. Thus we find that business suffers, because of the absence of one its most defining features – objectivity. Standardised credit appraisal procedures applicable to all and sundry is critical. Unstructured and adhoc credit processes harm institutions, just as weak Management Information Systems and mismanagement of Transaction Dynamics (TD) would. By TD we mean all the rituals that must be fulfilled before money is released to a borrower.

Emeka Osuji