Provisioning for Loan Impairment in MFIs

This note stresses the extent of variance amongst Indian MFIs in terms of nomenclature, methodologies and quantum of loan loss provisioning.The provision for loan impairment helps to assess the true profitability of an MFI. An inappropriate provisioning method distorts asset quality and financial performance. The paper states that:

• Different MFIs adopt different methodologies to arrive at the loan loss reserve, including the blanket approach and the ageing-based approach;
• Reserve Bank of India has prescribes minimum provision requirements for advances of non-banking financial companies;
• Provisioning practices vary across section 25 companies, trusts, societies and cooperatives as there are no statutory guidelines available;
• MFI evaluation frameworks make adjustments to financial statements to enable comparisons among different institutions due to the variance in the treatment of provision for loan impairment.

Differing provisioning methodologies and bases of presentation do not allow comparability between different MFIs, causing difficulty for lenders and investors in making sound decisions. There is, therefore, a need to move towards a consistent and standardized approach, while adopting the latest prudential norms to provide for possible portfolio risks.