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Sa-Dhan Microfinance Manager Series: Technical Note # 1

{ What is Portfolio at Risk? How to use it in Microfinance? |*

S
One of the most important tools used to assess a Microfinance Institution's (MFI's)
asset quality is Portfolio at Risk or PAR. It is a percentage (%), which represents the
“proportion of an MFI's total gross outstanding loan portfolio that is at default risk.”

The Formula for PAR is:

a Sum of Unpaid Principal Balance of All Loans with Payments Past Due
(1 to 365 Days and more)

Total Gross Outstanding Loan Portfolio


(Sum of Principal Outstanding of All Loans)

– It would be useful to see what PAR attempts to measure. One, it attempts


to measure the default risk in a portfolio by using past as well as future data.
And two, its estimation is based on the key question: if all delinquent
borrowers were to completely default, then how much (money) would the
MFI stand to lose?

D From this perspective, PAR provides a pessimistic estimate of the default risk in an MFI's
portfolio.

h
PAR has desirable standards. Generally speaking, sustainable institutions
have a PAR <= 2%. However, apart from absolute % values, two other
factors are important while using PAR: trends, in terms of
decreasing/increasing values as compared to the last (reference) period, as
well as the aged values of PAR.

a As far as trends for PAR is concerned, a decreasing Portfolio at Risk is positive.


However, this trend can be misleading, because a lower ratio can be obtained by
decreasing the numerator and/or increasing the denominator. In other words, sudden
and large disbursements of loans could mask the actual default risk. Also, in an MFI that

n
is fast expanding in terms of loan disbursements, the same limitation applies. And when
the repayment periods for these loans are yet to begin, the problem is magnified.
Likewise, re-scheduling, refinancing and loan write-offs can portray a lower PAR ratio,
while the (default) risk may still be high.
It is thus essential to understand how PAR is calculated:

S1
Step
From the MFI's total loan portfolio, determine all loans that are outstanding - a loan is
outstanding if, and only if, either principal, interest or penalties are due from the client.
Thus, a loan is outstanding when principal, interest or penalties due is greater than '0'.

a 2
Step
For every loan that is outstanding, create a loan repayment schedule, identify whether
the loan is delinquent and age the loan in days with regard to past dues.

To create the loan repayment schedule, one will have to look at the terms and conditions
agreed to at the time of disbursement for the loan type, which will be available in the


credit policy. Thus, it is imperative that the following data with regard to each loan is
available:
1. Loan amount disbursed
2. Loan term (number of installments)
3. Repayment frequency (weekly, monthly) and installment method

D
4. Interest rates – annualized, method of interest calculation etc
5. Sequence of appropriate repayments – penalties and interest first and
principal last (which is preferable)
6. Grace or moratorium period etc.
7. Any other terms and conditions that are relevant

h43
Step

Step
Do the same for all loans that are outstanding for the MFI, at the point of time when the
ratio is being calculated.

Aggregate loan repayment schedules for all loans, and summarize these (either in the
form of a simple ageing table report or a comprehensive portfolio report).

a5
Step
Using either of these reports, sum the unpaid principal balance of all loans with payments
past due (or overdue or arrears), and divide it by the Total Gross Outstanding Portfolio
(which is the sum of the outstanding principal amounts of all loans).This is the Total Portfolio
at Risk or PAR >=1 Day.

n6
Step
Arrive at PAR for past due loans with different ages as outlined below. PAR is usually
calculated for several age categories as given hereafter:
P
PAR > = 1 Day Sum of PAR 1-30 Days + PAR 31-60 days…
+ PAR > 365 Days

PAR > 30 Days Sum of PAR 31-60 Days + PAR 61-90 Days …
+ PAR > 365 Days

PAR > 60 Days Sum of PAR 61-90 Days + PAR 91-120 Days…

A
+PAR > 365 Days

PAR > 90 Days Sum of PAR 91-120 Days + PAR 121-180 Days ...
+PAR >365 Days

PAR > 180 Days Sum of PAR 181-365 Days


+ PAR >365 Days

R PAR > 365 Days (1 year) Sum of PAR


> 365 Days

There are certain minimum records required for calculating PAR.


They are:

Loan ledger with disbursement date, installment schedule and repayment data, on each
individual loan backed-up by a comprehensive credit policy outlining various terms and
conditions;

Aggregation of the loan ledger data with regard to delinquent and current loans – either a
simple ageing table or comprehensive portfolio report; and

The formats for these reports should follow best practices structure so that institutions
can be compared and contrasted on various aspects related to PAR.
Events and activities that affect or distort PAR:
Events/Activities that affect Impact on Impact on Impact on
PAR Numerator Denominator PAR
Rescheduling Decreases None Reduces the whole PAR Ratio,
Numerator while default risk still exists.
Refinancing (overdue Decreases Increases Reduces the whole PAR Ratio,
amounts are rescheduled Numerator denominator while default risk still exists.
and fresh amounts are
given to same client)
Write-offs Decreases Decreases Reduces the whole PAR Ratio,
Numerator Denominator while default risk still exists.
Fresh loan disburse- None Increases Reduces the whole PAR Ratio,
ments for which repay- Denominator while default risk still exists.
ments are yet to begin
(including those with a
grace/moratorium period)
Incorrect ageing of None None Distorts the age of past dues
past dues, based on the (over dues) and affects
installment /other provisioning, reserve and
methods of ageing sustainability.
Sequence of Decreases None Reduces the whole PAR Ratio,
payments, principal Numerator while default risk still exists.
first and interest next Distorts the age of past dues (over
dues) and affects provisioning,
reserve and sustainability and
through reduction of interest
payments (yield).
Weekly repayments None None Distorts the age of past dues (over
dues) and affects provisioning,
reserve & sustainability. Here, PAR
> 30 days will have to be
interpreted differently as for
weekly repayment loans, which
means that at least 4 installments
have become past due and are at
risk. This is very different from the
conventional PAR > 30 days used
for monthly repayment loans.
Balloon repayments, None None Distorts the age of past dues (over
as in case of agriculture dues) and affects provisioning,
loans (> 90 days or reserve, sustainability.
equal to a quarter) Here, PAR > 30 days, > 60 days,
> 90 days etc may have to
redefined and interpreted
accordingly.

*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