Sa-Dhan Microfinance Manager Series: Technical Note # 15

{ What is Subsidy Dependence Index? How to use it in Microfinance? |*

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Q: What is Subsidy Dependence Index or SDI?

A: SDI is a number and a very important measure of self-sufficiency that is getting
to be widely used. Developed by Jacob Yaron as part of his seminal work on Rural
Financial Institutions, the SDI is a unique measure because it takes into account the
implicit and explicit subsidies received by an institution while calculating self-sufficiency.

Q: Why is SDI considered important?

A: To be financially viable, a Microfinance Institution (MFI) cannot rely on donor funding
to subsidise its operations. If an organisation is not financially self-sufficient,
this Index can be calculated to determine the rate at which the MFI's interest rate
needs to be increased to cover the same level of costs, with the same revenue
base (loan portfolio), and without subsidies. Thus, the SDI represents the % increase
in 'onlending rate' required (for an MFI) to completely eliminate all subsidies, and
operate in a sustainable manner.
It is different from the adjusted financial self-sufficiency ratio, in that, it uses the
market rate rather than inflation to make the various adjustments to subsidies. This
Index also makes explicit the subsidy needed to keep the institution afloat, much
of which is not reflected in conventional accounting reporting.

Q: What is the formula for SDI?

A: It is as follows:

A (M-C) + E*M + K P
Total Amount Due (to be collected during period)

Q: What does it measure?

A: It is an important measure of sustainability of the lending operations. The
SDI measures the degree to which an MFI relies on subsides for its continued
operations. Looking at the SDI as a self-sufficiency figure allows determination of
the extent to which operations are subsidised, and also where these subsidies exist.

The SDI also offers prescriptions on what to do to eliminate these subsidies and become
fully sustainable. In terms of interpretation (please refer to the Box), an SDI
of 0 implies a fully sustainable MFI. Intuitively it makes sense, because this happens when
an MFI can cover its subsidies on borrowed funds, the opportunity cost of
its equity capital and all other subsidies from its profit.
A negative SDI suggests that an MFI has reached full or complete sustainability it is sustainable
and also generating a surplus. Likewise, a positive SDI (say for example, 100) indicates
that the MFI is a long way from sustainability, and needs to increase its on-lending rate
by 100% (i.e., double it), to be sustainable with the same costs and level of operations.
According to the SDI, five factors are critical for reducing or eliminating subsidy dependence:
adequate on-lending rates, high rates of collection, savings mobilisation, control of
operational costs and optimisation of portfolio rotation

Numerator of SDI
A (M-C) +E*M+K P = 0
P = A (M-C) +E*M+K
Profit = Subsidy on borrowings + Opportunity cost of capital
+ All other subsidies then SDI = 0
Profit > Subsidy on borrowings + Opportunity cost of capital
+ All other subsidies then SDI < 0
Profit < Subsidy on borrowings + Opportunity cost of capital
+ All other subsidies then SDI > 0

Q: What minimum records are required for calculating the Ratio?

A: Loan ledger with disbursement schedule and repayment data on each individual loan,
backed-up a comprehensive credit policy outlining various terms and conditions. Other
requirements are - aggregation of the loan ledger data with regard to delinquent and current
loans either a simple ageing table or a comprehensive portfolio report and key unadjusted
financial statements like the balance sheet and income statement, appropriately constructed.
Unadjusted financial statements are required to get an accurate picture of all types of subsidies
received by the institution. Thus, SDI calculated only by using an MFI's unadjusted financial
statements to determine the true value of the subsidies.

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Q: How does one calculate the SDI Ratio?

A: It is calculated in the following manner:
From the unadjusted financial statements and other sources of data and records,
calculate the subsidies on borrowings, (which is borrowings into the interest rate
differential between market rates of interest and actual concessional rate). Do this
for each source of borrowings. Please note that to get as accurate figures as possible,
one will have to use the actual borrowings ledger and repayment schedule.

Then, calculate the opportunity cost of equity capital, by multiplying total equity with
the market rate used above.

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Next, identify and place a value on all other subsidies including in kind subsidies.
Please refer to CGAP resources for various kinds of subsidies and methods of
allocating costs to them.

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Sum up the subsidy on borrowings, opportunity cost of equity capital and other
subsidies. This gives the total subsidies for the MFI. From this, subtract the MFI's profits
to get the numerator of the SDI.

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Then, calculate the average annual income by multiplying the average gross loan
portfolio outstanding (use formula below to calculate this), by the on-lending
effective interest rate. The actual income received during the period could also be
used this is the denominator of the SDI.

Divide Subsidies Profits by the Average Annual Income

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This gives the value of the SDI.

Q: What events and activities affect (distort) the Ratio?

A: This Ratio is affected by unaccounted, unreported and/or hidden subsidies with regard
to operations. Organizations providing micro-credit as well as other services can allocate costs
in such a way that their credit operations look more sustainable than they really are.
When MFIs allocate costs to subsidiaries or do not carry them on the books at all, for instance,
when donors meet certain costs, such as paying for consultants or health workers collect
loans/savings this Ratio is affected.

Q: What is the formula for calculating SDI?

A: From the portfolio report, calculate the average outstanding portfolio during the period
(for instance, a year), using the following procedure:
Divide the period (year) into appropriate sub-periods for example, a year could be divided
into 12 sub-periods of a month each;
Take the actual loans outstanding at the beginning of the period (say April 1, 2001);
Add to this, the sum of loans outstanding at the end of each sub-period (i.e., month);
Then, compute SDI as follows;
Average Loan Outstanding

(During Period) = B + E1 + E2 + E3+ ..... E12)

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*This technical note has been compiled specially for Sa-Dhan by Ramesh S. Arunachalam, using Best Practices material available with Sa-Dhan and stakeholders like
CGAP, SEEP and others. First published in August 2006. Sa-Dhan. Website : www.sa-dhan.org