Inefficiency will always make an appearance, wherever it exists. It cannot be hidden for too long. Therefore, in the deployment of scarce resources, managers must look out for the best way to utilise a resource such that its output is maximised. This includes the output of staff, both in the front and back offices.
For the credit and marketing staff of a Micro Finance Bank (MFB) on which this piece is focused, for instance, we have to ensure that expenses are kept down, while revenues are pushed up. Operating expense ratio is the starting point in the consideration of efficiency. The cost expended per borrower ratio will also show how well we manage the services rendered to clients. To be really productive, operators must ensure that staff are neither underutilised or overused. They have to be optimally engaged for best productivity. These relationships could be observed by looking at a number of ratios that relate cost to income, cost to borrowers, staff numbers to the number of clients each staff member is managing and such.
Operating expenses may come in trickles or small outlays but they add up to the huge cost that make or mar an institution. It includes all the expenses of running the business (including all the administrative and salary costs; such as depreciation and allowances of board members for sitting at meetings). These expenses are exclusive of financing costs and loans loss provisions. Similarly, extraordinary expenses and expenses from previous periods are excluded. Dividing these expenses by the average gross loan portfolio yields what is called operating expense ratio.
This ratio is simple and even common, but it is probably the most important mirror or reflection of how well a lending programme is managing its costs, vis a vis revenue. No wonder the operating expense ratio is regarded as the best indicator of the overall efficiency of a lending institution. This is why the ratio is also referred to as the efficiency ratio. It is the best way of measuring the institutional cost of delivering the loan services entailed in average loan size of a credit portfolio.
The a priori expectation is that this ratio should move in opposite directions with efficiency. In other words, the general rule is that the lower the operating expense ratio, the higher the efficiency of the institution. High operating expenses make it increasingly difficult for an operator to compete on the basis of price.
It is important that we not only understand the import of this number but also some ways in which it may be manipulated by vested interests. The size of the portfolio, not just because it is the denominator, is important in the analysis of operating expense ratio
It is important that we not only understand the import of this number but also some ways in which it may be manipulated by vested interests. The size of the portfolio, not just because it is the denominator, is important in the analysis of operating expense ratio. Some economies of scale accrue to those with large portfolios, though this advantage tends to be neutralised after a small firm reaches a certain volume (experts say up to $5 million). It follows therefore that a small firm may improve its efficiency by growing its loan portfolio. Although loan size has been identified as the most important influence on operating expense ratio, the methodology of lending is also an important factor.
Large loans do not necessarily cost more to administer. Indeed, they are cheaper to manage. In lending methodologies that involve very small loans, the ratio may be poor as administrative costs are higher. An example is the Village Banking model that make small loans and requires much training costs to be incurred. In such circumstances, it becomes important to also analyse and compare cost per borrower, and locational factors (urban and rural). Comparing costs per borrower removes the influence of loan size and shows efficiency as it ought to be.
The average number of active borrowers a staff is handling is a good indicator that may also be used to monitor staff engagement. Clients of a microfinance institution are in a way akin to the subscribers of a telecommunication service provider. You get to know when they buy a SIM card but you never know when they stop using it until you check, either from the billing operations or elsewhere. Telecom subscriber could just drop off a network without notice but their names remain as subscribers until the list is cleaned out.
Similarly, a client of a microfinance institution may stop borrowing but the name remains on the list of clients serviced by an account officer. It is important to know exactly which clients are active, otherwise a service provider may be carrying a long list of supposed subscribers not knowing that most of them have long since alighted from the service. It is the active clients/borrowers that shape the bottom-line. So, finding out the average number of active clients handled by each account officer is an important piece of information regarding efficiency.
There are some tricks that can be used to influence ratios in one direction or the other. Those who use ratios must be conversant with those influencing factors as to be in a position to make valid declarations based on such ratios. For instance, analysing average number of active clients as an efficiency and productivity ratio without understanding the lending methodology of the operator is futile. Number of active borrowers per credit officer is a ratio that depends on the lending methodology adopted by the microfinance institution. Group lending methodology may influence efficiency one way or the other.
This piece is an excerpt from my books: Entrepreneurship and Small Business Development, and Leading Essays on Microfinance to be publicly presented at NIIA on November 8, 2019
EMEKA OSUJI
