Microfinance Institutional Rating

Created in 1999, Planet Rating’s proprietary GIRAFE rating methodology has been evolving together with the microfinance industry. The Microfinance Institutional Rating methodology Smart GIRAFE, an update of Planet Rating’s GIRAFE methodology, will continue to provide an opinion on the long term sustainability and credit worthiness of Microfinance Institutions (MFIs), but it will now incorporate, in a single rating methodology, the financial, institutional, and social risks faced by microfinance institutions.

All specialized microfinance rating agencies have officially launched this new approach to microfinance ratings in October 2012.

Context
Recent crises in several microfinance markets (Morocco, Benin, Bosnia, Nicaragua, and Andhra Pradesh) have shown that an MFI, more than any other financial institution, lives in symbiosis with its clients, and that in the long run client difficulties become the MFI’s difficulties. Insufficient management of social risks has already impacted MFIs’ performance in several instances:

  • Poor client protection practices can in the medium term translate in higher credit risk and lower revenue quality;
  • Perception of lack of alignment of interest between practices and stated social goals can translate into reputation risk for an MFI or for the sector.

“As a result of the global financial crisis, investors increasingly recognize that improved corporate disclosure of ESG issues leads to better risk management, good governance and enhanced transparency, all of which are necessary to protect long-term returns. Companies need to understand this if they want to attract capital.” James Gifford, Executive Director of the Principles for Responsible Investment (PRI), March 2012.

As Institutional Ratings conducted in microfinance are meant to provide an opinion on the long term institutional sustainability and creditworthiness of MFIs, Planet Rating, in coordination with other rating agencies specialized in microfinance, has decided that the analysis of social risks, currently more closely looked at in social ratings, should be included in its Institutional Rating methodology.

Methodology development process
Since 2010, Planet Rating has gradually developed its approach to this methodological change, through:

  • Review of the performance of MFIs in the years that have preceded microfinance sector crises in Morocco, Benin, Bosnia, Nicaragua, Andhra Pradesh in India,
  • Own testing phase in cooperation with the MFI Al Majmoua in Lebanon and with support from AfD
  • Participation in a working group involving rating agencies, investors and MFIs facilitated by the Rating Initiative,
  • Review of historical grades given to 65 MFIs that underwent a Combined Rating (GIRAFE and Social Rating) to simulate the type of grades that would have been granted to these MFIs based on the new methodology.
  • Several pilots funded by Ford Foundation or paid directly by our MFI clients.

During 2011 our Smart GIRAFE methodology has been created, tested and prepared for a pre-launch phase. It integrates the evaluation of the management of social risks in our GIRAFE rating framework (see below). According to a survey conducted in October 2011 by OnValues on behalf of the Rating Initiative and involving 54 MFIs and major microfinance investors or asset managers, the integration of social risks in the evaluation of the long term sustainability and creditworthiness of MFIs is viewed positively by a vast majority of microfinance actors.

Planet Rating has launched the Smart GIRAFE in October 2012 in coordination with other rating agencies specialized in microfinance. This coordination is necessary to ensure a maximum comparability of all Microfinance Institutional Ratings and ensure that they all incorporate similar requirements in terms of Client Protection or Social Performance Management. 

GIRAFE rating analytical framework
The GIRAFE rating framework (in use until October 2012) is composed of the following areas of analysis:

 

SMART GIRAFE rating analytical framework

The SMART GIRAFE Framework is in use since October 2012
 

 

Rationale for change in the most important dimensions
Throughout the consultative process between rating agencies, investors and MFIs facilitated by the Rating Initiative, a wide consensus identified “Alignment of MFIs practices with stated goals and accountability”, Responsible Financial Performance and Client Protection as the most important dimensions to be added or enhanced in the Institutional Ratings. The SMART GIRAFE methodology integrates that feedback by including additional rating factors. These factors are new to the Institutional Rating but were already important parts of the Social Rating.

  • Alignment of MFIs practices with stated goals and accountability: the attractiveness and potential of the microfinance sector is due to its proven capacity to combine financial sustainability with ambitious social goals. In order to maintain the sustainability of this double bottom-line industry, it is crucial to ensure that the stated social goals are actually shared by decision-makers and translated into practices at all levels. Misalignment between the stated goals and practice can indeed harm the quality of the relationship between the MFIs and its partners (funders, governments, etc.), and generate a reputation risk.
  • Responsible Financial Performance: Financial performance earned at the expense of the social sustainability may as well harm the microfinance industry. Although precise standards in terms of responsible financial performance remain to be defined, transparency on current practices as well as identification of excessive ones (e.g. predatory or extortionate interest rates, profit margins far beyond benchmarks, disproportionate remunerations, very low salary levels for staff) are key to prevent abuses and mitigate the reputation risk for the sector. This rating factor will have a negative impact on the grade only in extreme cases.
     
  • Client protection: An MFI lives in symbiosis with its clients and its asset quality is notably based on the trust relationship created with its clients. Recent microfinance crises have shown that poor client protection practices translate in the medium term in higher credit risk and lower profitability for MFIs. The SMART Campaign has defined a detailed framework of seven principles to promote best practices in terms of client protection. Six of the principles are reviewed in the “Client Protection” rating domain while Appropriate Product Design and Delivery is reviewed in the “Efficiency and Profitability” domain under Adaptation of Services. There, Planet Rating assesses the MFI’s capacity to generate revenues on the long run with services truly adapted to the client’s needs. In the “Client Protection” rating domain, higher weights have been assigned to Prevention of Over-indebtedness, Transparency, and Fair and Respectful Treatment of Clients, than to the other principles. Low “Client Protection” grade (see the section on the rating system below) puts a cap on the overall grade.

Rating system
The rating system is a combination of classic weighing of rating factors, caps and notches.

  • The factors that are important for a good overall financial and institutional performance are weighed highly.
  • The factors that are key but not sufficient for a good overall financial and institutional performance are weighed less, but low performance on these items put caps on the overall grade.
  • The factors that are important but not applicable to all MFIs are used as a positive or negative notch that impacts directly the rating domain’s grade.

Caps are used for the following factors:

  • Microfinance sector: For MFIs to develop a sound and stable financial performance, a well-functionning microfinance sector is necessary (sound and well enforced regulation, healthy competition, market infrastructure such as credit bureau, transparency on MFI performance). A low grade on the Microfinance sector puts a limit on the overall grade (between B+ and A- depending on the gravity of the sector problems).
  • Risk Management: Poor risk management systems make the MFIs vulnerable to frauds or errors which might cause brutal and unanticipated changes in the performance of an MFI. A grade on Risk management of “d” or below caps the overall grade to C+.
  • Client Protection: To reflect the unique relationship between Client Protection and Asset Quality, the overall grade of an MFI is capped by its performance in Client Protection (to receive an A, an MFI should at least be rated “b” in Client Protection, to receive a “B”, it should be at least rated “c” on Client Protection, etc.).

Addition of indicators to rating methodology

Please refer to the page 3 of the concept note for these details. 

Smart GIRAFE Rating scale and Common Rating Grade Classification

ThE GIRAFE Rating Scale is presented below with the corresponding common rating grade classification for all microfinance rating agencies (in italic). A comparability table of rating grades of microfinance rating agencies will be published soon.

Smart GIRAFE Rating Grade: A++, A+, A, A-

Common Rating Grade classification: Excellent
Common definition: Excellent performance Low or well-managed short- medium term risk

Rating Summary
Current institutional, operational and financial performances are excellent to optimal when compared to industry standards. Medium and long-term plans are well-designed, execution capacity is very good, and goals are very likely to be achieved. Short and medium term risks are minimal and/or well managed. Long-term risks are adequately monitored and anticipated. Changes in the economic, political or social environment should have a limited impact on the institution’s financial condition given its ability to quickly adjust its strategies and/or take corrective actions.
 

Smart GIRAFE Rating Grade: B++, B+, B, B-

Common Rating Grade classification: Good
Common definition: Good performance; Modest or well-managed short- medium term risk

Rating Summary
Current institutional, operational and financial performances are satisfactory when compared to industry standards. Medium and/or long-term plans are adequately designed, execution capacity is good and goals are likely to be achieved. Short and medium term risks are low and/or well managed. Areas for improvements have been identified and are being addressed. Changes in the economic, political or social environment might have an impact on the institution’s financial condition that should however remain moderate.
 

Smart GIRAFE Rating Grade: C++, C+, C, C-

Common Rating Grade: classification: Good
Common definition: Good performance; Modest or well-managed short- medium term risk

Rating Summary
Current institutional, operational and financial performances are below comparable industry standards. Short and medium term risks are moderate-high but are not fully addressed. Most areas for improvements have been identified, but medium and long-term plans miss one or several critical elements, execution capacity is weak and many goals are unlikely to be achieved. Most management processes and systems are in place but need to be refined or updated. The institution is vulnerable to major changes in the economic, political or social environment.
 

Smart GIRAFE Rating Grade: D, E

Common Rating Grade: classification: Weak
Common definition: Weak or poor performance; High to very-high risk

Rating Summary
D: High risk: Important weaknesses in operational and financial areas result in high institutional vulnerability and potential risk of default. Performance is very poor in several important evaluation areas.
E: Immediate risk of default: Existing operational and/or financial and/or strategic weaknesses create an outstanding risk of default. Performance is very poor in most evaluation areas.