The Role of Credit Risk Policy
In managing credit risk, an effective Credit Risk Policy (CRP) is paramount. The CRP serves as a guiding framework for MFIs, outlining the principles and strategies to assess, control, and mitigate credit risk. Its significance cannot be overstated, and here’s why:
1. Diversification and Avoiding Concentration Risk:
A well-designed CRP emphasizes diversification. MFIs should avoid overconcentration in any specific area or among particular groups of borrowers. Concentration risk is the threat that a significant portion of a loan portfolio is exposed to external factors, such as regional economic downturns or natural disasters. By expanding operations across multiple districts, MFIs can decrease their vulnerability to localized risks.
2. Responsible Lending:
A robust CRP ensures that MFIs steer clear of over-indebting borrowers. Over-indebted clients may struggle to meet their repayment obligations, leading to higher NPAs. Moreover, extending loans to clients who are already in default, as indicated by credit bureaus, can further escalate credit risk. The CRP can help MFIs strike a balance between financial inclusion and responsible lending.
3. Arrear Management over Disbursement Pressure:
The pressure to increase loan disbursement can sometimes lead field staff to compromise on credit processes. This invariably results in elevated instances of arrears, adversely impacting borrowers and the MFI. A comprehensive CRP focuses on the importance of arrear management, ensuring that MFIs address the root issues while maintaining growth.
4. Borrower Data Utilization:
A well-executed CRP encourages MFIs to utilize borrower data effectively. This includes regularly updating credit bureau information to identify clients’ repayment behavior. Such data-driven insights enable MFIs to make informed decisions about lending and managing credit risk.