GUIDELINES FOR EVALUATION OF NON-

GOVERNMENTAL ORGANIZATIONS ENGAGED IN

MICROCREDIT ACTIVITIES

The Technical Audit Unit of the Ministry of Finance has the duty of
inspecting, appraising quality of performance, ascertaining value for money
directed to different development programmes and advice the Government
on corrective actions to be taken. The Technical Unit complements existing
systems and procedures on public financial accountability by focusing on the
technical aspects of project delivery.

In this context, the present guidelines contain the approach that the Unit will
utilize to evaluate the operations of all non-governmental organizations
engaged in microcredit..

Non-Governmental Institution that comply with the conditions set forth in

these Guidelines would qualify for continued government funding and to
receive a recognition as MicroCredit Institutions (MCIs).

Introduction

According to the National Microfinance Policy 2000 (NMP), the Government

on Tanzania considers microfinance systems as “an integral part of the
financial sector that falls within the general framework of its Financial Sector
Reform Policy Statement of 1991”. The overall objective of the NMP is “to
establish a basis for the evolution of an efficient and effective microfinancial
system in the country that serves the low-income segment of the society, and
thereby contribute to economic growth and reduction of poverty”.

In this context, the NMP covers the provision of financial services to

households, small holder farmers and small and micro enterprises in rural
areas as well as in the urban sector. Clients use these services to support their
enterprises and economic activities as well as their household financial
management and consumption needs. Financing for all types of legal
economic activity is included, e.g. commerce, trade, manufacturing and
agriculture.

According to the NMP, a wide range of institutions will be involved in the

provision of microfinancial services, including NGOs. It is expected that these
institutions apply “best practices” to provide these services effectively,
efficiently and sustainably, combining commercial financial principles with a
variety of ways to adapt service delivery techniques to the circumstances of
low-income clients. Some of the best practices that should be applied by these
institutions, particularly NGOs for the purposes of these guidelines, are:

1. Full knowledge of its operational costs and the market they face, in
order to set their lending rate and the prices of other services at such
levels that those costs are covered.

2. Adequate information systems to monitor the status of their loan

portfolio, particularly in order to promptly manage delinquent clients
and to recognize the cost of credit risk, by implementing an appropriate
policy for provisioning and write-off of bad loans.

3. Transparent financial and operation information that gives a clear

picture of the status of the organization, including outreach,
profitability (net of any subsidies received) and portfolio quality.

4. Lending techniques and products adapted to the circumstances of low

income clients, including the use of collateral substitutes and repayment
incentives to protect themselves against risk.

5. Sound governing structures.

Regulatory framework for microfinance

Bank of Tanzania has issued the Microfinance Companies and Microcredit

Activities Regulations 20041, that contain accounting and internal control rules
geared towards securing the adoption of best operational practices by banks
and financial institutions engaged in microfinance.

The National Board of Accountants and Auditors has, in turn, incorporated2

these regulations into Tanzanian Financial Accounting Standards No. 8
“Disclosures in the Financial Statements of Banks and Similar Financial
Institutions”, thereby making them of mandatory observance by all
institutions that are engaged in microfinancial activities.

An effective observance of these rules by NGOs engaged in microfinance,

would go a long way in reaching the first four “best practice” objectives
previously described. With regards to governance, the Ministry of Finance has

1 Issuance of these Regulations would be required prior to release of the Guidelines.

2 Modification of TFAS would be required prior to the release of these Guidelines..

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amended Public Finance Regulations in order to clarify that the Chief
Executive Officers of NGOs that access public funds, have the duties and
responsibilities of Accounting Officers under the Public Finance Act.

Evidence of the observance with this regulatory framework on the part of an

NGO, would allow it to qualify for government funding and to gain
recognition by the Ministry of Finance as a specialized MicroCredit Institution
(MCI).

Guidelines for evaluation of NGOs as MicroCredit Institutions

1. Independent audit report prepared by an auditing firm registered with

Bank of Tanzania, with an unqualified opinion and explicit
certification of compliance with going-concern criteria.

Auditing practices shall be in conformity with Tanzanian Auditing

Standards (issued by the National Board of Accountants and
Auditors) and accounting practices used in preparation of financial
statements must be in conformity with Tanzanian Financial
Accounting Standards (issued by NBAA, adopting accounting rules
issued by BOT).

2. Specialization in financial services, certified by the independent

auditor. No more than 5% of the assets or the administrative
expenses should be associated with non-financial services.

3. Efficiency analysis: the final objective is to verify that the institution

is both profitable and competitive. Although it is possible to speak in
broad terms about benchmarks or targets of performance and
comparison, the most useful application of efficiency indicators is
within a single institution over time. Issues of comparability become
secondary to trend; for example, an administrative expense ratio
trending downward, or a client per officer ratio trending upward, are
changes for the better. Increased loan officer productivity and
portfolio quality help reduce total administrative and provisioning
expense, yielding increased profitability.

In this context, targets and trends will be used as qualifying criteria,

particularly until the microfinance industry in Tanzania establishes
standards of efficiency (as provided by the NMP).

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Targets or benchmarks

a) Profitability (Net income adjusted for inflation/net assets):

more than 12% per annum

b) Operating expense ratio (administrative expenses/average loan

portfolio): less than 25%

c) Portfolio at risk 30 days (Outstanding balance of loans with

installments past due for 30 days or more plus restructured
loans/total outstanding loan portfolio): less than 5%

Trends

Qualification for government funds could also be granted to

institutions that show a positive trend in efficiency ratios, but have yet
to reach the desired target or benchmark. For these purposes, positive
trend is a yearly improvement of at least 15% in the ratio.

Recognition as Microcredit Institutions should only be granted upon

actually reaching the target or benchmark.

Other performance indicators that could be analyzed to gain an

insight into the driver elements for efficiency are:

Benchmark today in the industry

Performance indicators:
(worldwide):
Portfolio at Risk:
The Best microfinance portfolios have PAR
Outstanding balance on arrears > 30
> 30 days of less than 3% with an average
days + total gross outstanding
of 6%
refinanced (restructured) portfolio)/
Total outstanding gross portfolio
Risk coverage ratio: The best institutions with microfinance
Loan Loss Reserves/(outstanding portfolios have at least 90% of Risk
balance on arrears over 30 days + Coverage Ratio, however on average they
refinanced loans) have around 70% coverage

Write-off Ratio: The best institutions have 1% write-offs

Write-offs/Average Gross Portfolio
Loans per Staff:
Number of Loans/Total Staff
Cost of Funds Ratio:
with an average range of 2-3%
The best ratio for institutions with
individual lending is 215
The cost of funds ratio reflects interest rates
h k

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 Benchmark today in the industry
Performance indicators:
(worldwide):
Interest and Fee expenses on Funding in the local markets
Liabilities/Average Funding liabilities
Leverage: The average debt/equity ratio for the best
institutions with microfinance portfolios
Total Liabilities/Total Equity was 4 in 2000
Portfolio yield:
Average portfolio yield for the sector in
Interest and Fee income/Average 2000 was 39.5% down from 41.5% in 1999
Gross portfolio
Client Retention Rate:
(Number of borrowers at the end of the period A normal retention rate should be over
– number of new borrowers for the 80%.
period)/Number of borrowers at the beginning
of period

4. An alternative requirement for recognition as Microcredit Institution,

instead of efficiency analysis by the Technical Audit Unit, is to
require a Rating or Assessment Report prepared by an independent
agency of international prestige.

These reports would usually have two parts:

a) Adjustment of financial statements: to better reflect its situation at

the light of prudent accounting principles. The most common
adjustments3 and their impact is the following:

Adjustment Effect on Financial Statements Type of Institution most

affected by Adjustment
1. Loan loss Usually increases loan loss Institutions that have unrealistic
reserve and provision expense on income loan loss provisioning policies
statement and loan loss reserve on
provision
balance sheet
expense
adjustment
2. Write-off On balance sheet reduces gross Institutions that do not write off
adjustment loan portfolio and loan loss non-performing loans
reserve by an equal amount, so aggressively enough.
that neither net loan portfolio nor
the income statement is affected.
Lowers portfolio at risk indicator.
3. Subsidized cost Increases financial expense to the Institutions with heavily
of funds extent that the institution’s subsidized loans
adjustment liabilities carry a below-market

3 For a detailed discussion on methodologies of adjustment, consult The ACCION CAMEL

(www.mip.org/pubs/mbp/camel.html).

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 Adjustment Effect on Financial Statements
rate of interest. Decreases net
income.
4. In-kind subsidy Increases administrative expense
adjustment to the extent that the institution is
receiving subsidized goods or
services. Decreases net income.
5. Inflation Increases financial expense. May
adjustment generate a reserve in the balance
sheet’s equity account, reflecting
that portion of the institution’s
retained earnings that has been
consumed by the effects of
inflation. Decreases profitability
and “real” retained earnings
6. Reversal of Reduces interest income and net
interest income profit on the income statement
accrued on non- and equity on the balance sheet
performing loans
Type of Institution most
affected by Adjustment
Institutions using goods or
services for which they are not
paying a market cost.
Institution’s funded more by
equity than by liabilities will be
hardest hit, especially in high-
inflation countries.
Institutions that continue
accruing income on delinquent
loans past the point where
collection becomes unlikely, or
that fail to reverse previously
accrued income on such loans.

b) Rating or assessment of the institution: criteria and methodology

vary widely among rating and assessment institutions. As a
general rule, a rating or assessment in an “above average” category
would be required for MCI recognition.