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Glossary
Adjusted return on how productively the MFI has employed its assets. Reflects the MFIs
assets (AROA) real unsubsidized operating profitability relative to its earnings base.
Formula: Adjusted Operating Profit/ Average Total Assets
Adjusted return on the return on the capital of the MFI. Formula: Adjusted Operating
equity (AROE) Profit/Average Equity
Administrative measures the overall operating efficiency of a microfinance institution.
efficiency ratio Useful in comparing across various MFIs, because it does not include
the cost of funds, and does not penalize institutions that are accessing
commercial sources. Formula: (Operating Expense - Cost of Funds +
In-kind Donations) / - Loan Loss Provision Expense + Average
Outstanding Portfolio.
Adverse selection arises from information asymmetry in a market, such as the credit
market. It is the problem a lender has in distinguishing between good-
risk and bad-risk investments, because the borrower has information
that the lender does not.
Aging of arrears refers to categorizing loan amounts past due according to the amount of
time the amounts are past due. Aging categories are often 30 day
increments such as 1-30 days past due, 31-60 days past due, 61-90 days
past due, and greater than 90 days past due.
Agreement the written, formal contract between the donor and recipient. An
agreement specifies the performance, reporting and other obligations
the recipient assumes by accepting the donated funds.
Amortization schedule the schedule for paying off the interest and principal of a loan.
Arrears rate measures the amount past due in a portfolio. Under-estimates the level
of risk in the portfolio. See Portfolio at Risk. Formula: Amount Past
Due / Gross Outstanding Portfolio
Assets the economic resources owned by the institution that provide future
value to the institution. Cash, the loan portfolio, furniture and
equipment are examples of assets.
Average portfolio used for calculations that require a comparison of assets to income.
Formulas: 1. Most accurate: (Portfolio Outstanding at the End of Each
Month in the Period + Portfolio at the End of the Previous Period) / (1
+ Number of Months in the Period) 2. Less accurate: (Portfolio
Outstanding at the End of the Previous Period + Portfolio Outstanding
at the End of Current Period) / 2
Balance sheet a report on the financial position of an organization at a specific point
in time. The balance sheet provides a summary of the institutions
 assets what the institution owns, and claims on those assets, or what the
institution owes at a specific point in time, such as on December 31,
2002.
Business plan a strategic plan that places financial planning and financial
performance at its core. Charts the future course of an institution
through a realistic projection of operations. Incorporates financial
models that allow managers to understand the financial implications of
their decisions and of changing conditions.
Client load the average number of clients served by one loan officer. Formula:
average number of active loan clients during the period / the average
number of loan officers during the period.
Commission a one-time charge, usually a percentage of the loan amount that is
charged at the time of disbursement. A commission increases the
effective interest rate of a loan.
Compensating balance a requirement that the borrower maintain a minimum amount in a
savings account in order to receive a loan.
Declining balance an interest rate calculated based on the principal amount of the loan
interest rate actually in the hands of the borrower during each amortization period.
Default the situation that occurs when a borrower cannot or will not repay
his/her loan and the MFI no longer expects to receive repayment.
Delinquency the situation that occurs when loan payments are past due. A delinquent
loan (or loan in arrears) is a loan on which payments are past due.
Delinquency is also referred to as arrears or late payments.
Discounting the process of deducting interest, commissions or fees from the initial
loan amount before the loan is disbursed. Discounting reduces the
initial loan amount actually received and therefore increases the
effective interest rate.
Effective interest rate the rate that converts all the borrowers financial costs for a loan into a
single declining balance interest calculation. It includes the effects of
interest rates, whether they are calculated on a flat or declining basis,
payment schedules, commissions, fees, discounting, and compensating
balances. The effective rate allows a calculation of all financial charges
as a percent of the loan actually held by the client during each payment
period. It is the rate that a client actually pays based on the amount of
loan proceeds actually in the clients hands. Distinguished from the
APR because it includes the effect of compounding. See formula on
page 62.
Efficiency an operation is efficient when it produces the greatest output for the
least input.
Efficiency ratio see administrative efficiency ratio, operating efficiency ratio.
Equity the remaining interest in the assets of an organization after its liabilities
have been satisfied. Sources of this interest may be donor or investor
funds or the organizations retained earnings.
Equity participation the provision of equity to an institution by donors or investors. Equity
participants expect to share in the financial returns of the organization.
They are distinct from creditors whose interest, in the form of
liabilities, is due regardless of the institutions performance.
Fee a charge, usually a fixed amount independent of the loan size, levied as
part of the loan process. Fees increase the effective interest rate of a
loan. If the amount is fixed, their impact on the effective interest rate
will vary according to the loan size.
Financial the process by which the formal and informal financial sectors manage
intermediation liquidity in the economy, reallocating liquid resources by mobilizing
savings from institutions and individuals and allocating it in the form
of credit to institutions and individuals.
Financial productivity the financial output produced per input. The most financially
productive operation is one that produces the greatest revenue for the
least cost. Example: Average outstanding portfolio per loan officer
Financial statements for an MFI, financial statements refer to the three basic financial
reports that show the financial position of an MFI. These are the
balance sheet, the income statement and the portfolio report. Financial
statements also may include a fourth report, the Cash Flow Statement.
Financial self- measures the degree to which operating income covers the adjusted
sufficiency operating expenses. Expenses include all operating expenses included
in operational self-sufficiency as well as the value of subsidies and the
cost of inflation to equity. Equivalent to AROA because it includes the
same information. Formula: Operating Income /Adjusted Operating
Expenses.
Flat interest rate A flat interest rate is an interest rate calculated on the basis of the stated
initial principal amount of the loan irrespective of the payment plan,
(not on the amount of the loan actually in the hands of the borrower
during each amortization period.)
Fungibility the interchangeability of things that are identical or uniform.
Frequently applied to money because any given amount can be used
interchangeably with any other amount. The use of financial resources
is highly fungible as the household budget shifts between consumption
and investment in response to changing needs and opportunities. The
divide between business and personal assets is often not clear.
Generally Accepted the set of internationally accepted accounting standards.
Accounting Principles
(GAAP)
Gross portfolio the total amount of outstanding loans including the amount for which
repayment is not expected, which is represented by the loan loss
reserve.
Horizontal growth growth based on replicating a standardized retail model in new
geographic areas. Although horizontal growth has been the norm for
 MFIs, simple horizontal expansion can make it difficult to quickly
introduce new products or changes to products.
Income statement one of a set of financial statements, the income statement shows what
the institution earns and spends over a period of time, for example from
January 1, 2002 through December 31, 2002. It reports the net income,
profit (or net loss).
Inflation Adjustment (Average Equity Average Fixed Assets) x Inflation Rate
Formula
Informal sector refers to the sector of the economy that includes micro and small
enterprises. In developing countries, the informal sector can account
for one to two thirds of total employment. Actors in the informal sector
usually lack access to the full range of financial services and to
financial services at reasonable prices.
Leverage using equity to access commercial funds. MFIs can leverage
commercial funds only if they have achieved financial viability
because sources of commercial funds are concerned with receiving a
market return on their investment. The Basel agreements enable a bank
to leverage up to 12 times its equity with debt. MFIs have leveraged 5
to 8 times their equity.
Liabilities a businesss obligations to pay money or provide goods or services to
another party. Liabilities are claims against a firms assets. Examples:
An outstanding bank loan or savings the institution has mobilized from
others.
Liquidity the degree to which assets are held in the form of money or in a form
that can easily and immediately be converted into money. Liquidity can
also be defined as the ability of an institution to meet its current
financial obligations.
Loan loss provision an accounting entry on the expense side of the income statement. It is
expense made to adjust the loan reserve so that the loan loss reserve accurately
reflects the risk of default in the portfolio. Loan loss provision
expenses increase the loan loss reserve.
Loan loss rate measures the amount the institution has declared non-recoverable, or
written off, as a percentage of the average outstanding portfolio.
Loan loss reserve an accounting entry on the balance sheet that represents the amount of
the outstanding portfolio that is not expected to be recovered. The
amount of the loan loss reserve is based on historical information
regarding loan default and the aging analysis of the current portfolio
and should be calculated periodically, or set by the Central Bank.
Loan period according to the loan agreement, for loans paid in regular installments,
the length of time between installments.
Loan term according to the loan agreement, the length of time between the date of
disbursement of the loan and the date it is expected to be fully repaid.
Methodology refers to how microfinance services are delivered to the client.
Elements of a service delivery methodology include type of guarantee
or collateral required, processes for client selection, and policies for
receiving additional loans.
Moral hazard arises from the incentive of an agent holding an asset belonging to
another person to endanger the value of that asset because the agent
bears less than the full consequences of any loss.
Net portfolio the gross outstanding loan portfolio minus the loan loss reserve. The
net portfolio is the portion of the gross outstanding loan portfolio for
which repayment is expected.
Nominal interest rate the stated rate of interest to be paid on a loan. The rate the lender says
the borrower will pay, it can be either a flat or declining balance rate.
Nominal interest rates reveal little about the costs of a loan.
Operational efficiency the cost per unit of loan outstanding (i.e., what it costs the MFI to lend
each unit of money). Formula: Operating Expenses + In-kind
Donations / Average Outstanding Portfolio.
Operational self- measures the degree to which operating income covers operating
sufficiency expenses. Operating costs are adjusted for generally accepted
accounting practices. It does not include covering the value of
subsidies received or the cost of inflation. Formula: Operating Income /
Total Operating Costs)
Opportunity costs non-cash costs incurred by the borrower associated with foregone
opportunities associated with accessing the loan. These costs are
frequently greater than financial and transaction costs. Examples
include attendance at loan-related meetings and the corresponding
absence from the business and the costs of maintaining forced savings
rather than using the money directly in the business.
Outreach the ability to reach large numbers of people, especially the very poor
and less advantaged, with quality financial services. Outreach is
considered along three dimensions: level of income or advantage of
clients, scale of services, and quality of services. Deep outreach refers
to reaching very poor or hard-to-reach clients. The latter could be
women in certain societies or clients in sparsely populated areas with
minimal infrastructure.
Outstanding balance the loan balance. That is, the portion of a loan that has not yet been
paid whether it is due or not.
Periodic rate includes all the costs of a loan, including the effects of interest rates,
payment schedules, fees and compensating balances, such as forced
savings. It expresses all income from the loan as a single declining
balance interest calculation, or as a percentage of loan principal
outstanding. APR/number of periods = periodic rate. See formula on
page 62.
Physical productivity refers to the physical output produced per input. An MFI may achieve a
high level of physical productivity but still may have a low level of
 financial productivity. Measure: number of active clients per loan
officer.
Portfolio at risk rate measures the level of risk in the portfolio by comparing the balance of
all loans that have one or more payments past due to the outstanding
portfolio. The portfolio at risk rate is considered the most appropriate
measure of delinquency. Formula: Outstanding Balance of Loans with
Payments Past Due / Current Portfolio Outstanding
Portfolio quality refers in general to the amount of risk of default in the loan portfolio. A
high quality portfolio contains a lower amount of risk. Portfolio quality
changes continually as loans are disbursed, payments are made, and
payments become due.
Portfolio yield measures what the portfolio actually earned. Tells us about the MFIs
pricing policy. Formula: Income from Lending / Average Net Portfolio
for the Period. See Yield gap.
Product, or Service refers to what is delivered to the client. Elements of a loan product
include the loan size, price (interest rate), repayment intervals, term
and purpose.
Profitability when operating income is greater than adjusted operating expenses
Return on assets see (adjusted) return on assets.
Request for proposal a donor agencys formal, written solicitation of funding proposals.
(RFP), or Request for Specifies what the donor seeks to fund, the required format and content
application (RFA) of proposals, and the details of the funding process.
Real interest rate An interest rate adjusted to compensate for the effect of inflation. A
negative real rate implies that the rate of interest charged is less than
the inflation rate. See formula on page 63.
Relevant portfolio in calculating the loan loss rate, the relevant portfolio is the portfolio of
loans disbursed to which the losses are attributable.
Repayment rate measures the amount of payments received with respect to the amount
due. Does not measure the risk in the portfolio (as do the portfolio at
risk and other delinquency measures.)
Required yield on the income the institution will need to receive in order to cover all
portfolio costs. The required yield is often expressed as a percentage of the
average outstanding portfolio.
ROSCA, rotating a self-organized group of individuals who contribute a fixed sum on a
savings and credit regular basis to provide each other, in turn, with a sum of money.
association
Service, or Product refers to what is delivered to the client. Elements of a loan product
include the loan size, price (interest rate), repayment intervals, term
and purpose.
Service delivery see methodology.
methodology
Spread the difference between two measures, usually expressed as percentages.
Subsidy Adjustment (Average Liabilities x Shadow Price of Funds) - Actual Interest and
Formula Fee Expense
Sustainability used interchangeably with viability; see Viability
Transaction costs money paid out to access a loan and not paid directly to the MFI. These
are costs other than those paid to the financial institution but often
imposed by lenders through the delivery system. Examples include
transportation costs involved in receiving and repaying a loan fees paid
to obtain financial documents or business registration, and the cost of
maintaining a bank account that is a requisite for obtaining a loan.
Trend analysis the comparison of financial ratios for one financial institution over
time. Trend analysis is a key to analyzing financial ratios. No ratio is
an island.
Vertical growth growth within existing service areas through product diversification
and expanding clientele.
Viability refers to financial and institutional viability. Financial viability is the
ability of a microfinance institution (MFI) to cover its costs with its
interest and fee revenues. Institutional viability is the capacity of the
institution to continue to thrive as a sound service delivery
organization. Financial viability allows MFIs to maintain their
operations into the future, independent of donor subsidy or grant
funding.
Write-off policy the institutions policy governing when loans are written off, or
declared non-recoverable and deducted from the loan loss reserve. A
standard recommendation is that loans past due for one year without
any payments being made should be written off.
Yield gap a comparison between what the portfolio actually earned and what it
should have earned given pricing and product structures. A yield gap
may be caused by delinquency, fraud, poor MIS, or structure of loans
and disbursement.