Loan officers have a tremendous effect on the productivity and income of the MFIs that employ them, and their compensation often comprises over half of the MFI’s costs. Most MFIs are double-bottom-line organizations dedicated to the social mission for which they were founded as well as to achieving financial health.  So it’s no wonder that management has an interest in tools that encourage and promote superior loan officer performance, in relation to social as well as financial goals. One such tool is a staff incentive scheme.

A recent visit to a Nicaraguan MFI provided me with firsthand insight into a mission-driven organization that uses a monetary incentive scheme to motivate and reward its loan officers. I approached the project with the assumption that some degree of tradeoff exists when an organization is balancing social and financial objectives. But how much of a tradeoff is there really? Focusing on the social mission can have financial payoffs in the form of loyal clients willing and able to pay back their loans. On the other side, by ensuring strong financial performance, the MFI is also increasing the likelihood that it will reach sustainability, scale, and scope and thereby continue to be able to provide necessary services to the world’s poor. So if the two goals are not mutually exclusive, how can an incentive scheme be designed to promote both?

Within the organization’s staff incentive scheme, loan officers are able to earn 50 percent of their total income in bonuses (effectively doubling their salary). As the cornerstone of my master’s thesis research, I set out to answer the important question: how does this MFI’s incentive scheme influence loan officer behavior, and more importantly do monetary incentives introduce a risk that loan officers will drift from the organization’s social mission?

The staff incentive scheme I observed targets five indicators, representing a mix of social and financial goals. These include loan portfolio and number of clients, both of which contribute to the overall productivity of the MFI. Striving for growth in the loan portfolio and expanding the target client base can have both positive social and financial impacts, in the form of greater outreach to clients (social) and helping the MFI reach scale (financial). [1]The incentive scheme rewards loan officers for referring clients to the healthcare services offered by the organization, which is closely aligned with its social mission to support the health of its clients. Maintaining low rate of delinquency is the main focus of the system– not only is this indicator given most weight (25 percent), but failure to meet the target results in disqualification from all other incentive bonuses. Similar to productivity, the target of low delinquency can be characterized as both socially and financially motivated.

While this particular incentive scheme is designed with financial targets as the primary objective, it is important to note the mission-focused organizational culture in which it is embedded. Interviews with management revealed the emphasis they place on fostering a strong culture focused on the social aspect of the organization’s work, via staff training, workshops, and goal-setting.  A survey of loan officers confirmed that management prioritizes this culture, and that it has an effect on loan officer behavior. For example, one loan officer commented that “management provides training to staff. They are concerned with knowing what each loan officer is doing. They ensure that staff is doing quality work and providing good service to clients.” While a monetary staff incentive scheme aimed at financial indicators might introduce the risk that loan officers lose sight of the social focus, this is less likely to occur in a financial institution where every loan officer can recite the mission statement and understands the social significance of the organization’s work.

What have I learned so far? That the indicators can’t neatly be divided into social and financial groups, and that an understanding of the incentives goes hand-in-hand with an understanding of the organizational culture into which they are introduced. In the coming months, I’ll be delving into loan officers’ survey responses to find out more about how the incentive system impacts their behavior – stay tuned!

1 Rashmi Ekka (2010): Integrating social performance management into microfinance capacity building – staff incentives.

Image credit: microlinks.org

Unless 10,000 people read this blog post in the next 15 days, I will be fired. So please read this post! If I hit the desired readership not only will I keep my job, but I will get a bonus equal to a month’s extra pay. PLEASE read it! If you don’t, you might not like what happens. Seriously, you and your family could be affected. Don’t make me come to your house and force you to read it. OK, that’s it! I’m coming to confiscate your computer until you agree to read it.

Pressure to perform, especially against unrealistic targets, can lead to a temporary breakdown in ethical judgment. I’m not actually facing tremendous daily pressure to perform, and nothing will happen to me (or you) if you don’t read this post. But it illustrates is the kind of world in which microfinance loan officers live — the brave souls that I like to call the hardest-working people in microfinance.

Unfortunately, loan officers are often under-prepared for a job that often puts them at direct odds with the people they are meant to serve. When clients don’t repay their loans, the officers suffer. And some make the clients suffer in return. With little guidance or practical instruction on the ethical “do’s and dont’s” of debt recovery, some loan officers perpetrate serious ethical violations in hopes of extracting loan repayments from clients.

Loan officers deserve to work under explicit policies for acceptable and unacceptable debt collections practices, and to receive practical training on how to face the harsh world of overdue loans. “Don’t mistreat clients” is not a policy, it’s a mantra. And mantras are good for chanting, but easily forgotten when a loan portfolio is underperforming. Let’s look at some of the ways acceptable collections practices can be misinterpreted:

Remember that our hardest-working employees also have the most interaction with clients. Let’s train credit staff to behave ethically even when they are under immense pressure to recover loans. Concerning the pressure we place on them, that’s another blog post…

Image credit: Orionman

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Dispatch from the Field: Loan Officer Incentives – A Delicate Balancing Act

Incentives are among the most controversial of issues in finance.  They raise provocative questions: Why they are necessary? Who receives them? How should they be given?  Various stakeholders are active in the debate, from Wall Street to microfinance. There are numerous arguments for and against incentives that match an equally sizeable slew of theories about human behavior. In a recent publication, Ron Schmidt from the University of Rochester discusses “Are Incentives the Bricks or the Building?”

Incentives are able to promote positive results from their collaborators through well paired with individual motivations and with organizational goals and culture. Administering incentives is important because they promote work and personal motivation, however, as Professor Schmidt argues that, “incentives can be powerful enough to encourage employees to ignore trade-offs beneficial to firm performance when making [such decisions] leads to reduced incentive pay.” This is a story familiar to us in microfinance: sometimes loan officer incentives are designed to reward  portfolio growth over quality which can motivate individual loan officers to make decisions based on self interest rather than sound credit decisions that might make loan sizes smaller and reduce incentive pay accordingly. This is why we have argued in the Smart Campaign that in order for institutions to prevent overindebtedness “[p]roductivity targets and incentive systems [must] value portfolio quality at least as highly as other factors, such as disbursement or client growth. Growth is rewarded only if portfolio quality is high.”   

Additionally, Schmidt argues that some of the above issues can be curbed by looking at the staff you hire. “[E]ffective choice of personnel and attention to incentives can help minimize the complications resulting when actions motivated by private interests differ from the actions that contribute to increases in shareholder value.” This is important for microfinance because MFIs need to hire qualified personnel who also share ethical values akin to the institutional mission, as the Smart Campaign posits under the Client Protection Principle on ethical staff behavior. 

Schmidt provides general principles on pay and incentives, relevant to microfinance even though they weren’t written with that in mind.

1. Pay what the labor market demands to get the right talent, but don’t break the bank.
2. Be careful! Keep bonus plans simple and open to adjustments for changing circumstances.
3. If the company does well, give everyone a temporary (not ongoing) bonus.
4. Give especially generous rewards to teams or individuals when special contributions can be unambiguously demonstrated.
5. Reward character-rich behavior; give those individuals opportunities to advance.

The Microfinance industry faces important questions: How do we select character-rich individuals as loan officers (and keep them from being poached by the competition)? How do you encourage the development of an ethical corporate culture within an organization? And also how do you establish an adequate mix between staff incentives, financial performance, and social mission in order to operate sustainably? Please share your thoughts.  

For a field perspective on incentives and microfinance, see the contribution from our guest blogger, Eleanor Coates, “Dispatch from the Field: Loan Officer Incentives – A Delicate Balancing Act.”

Flickr credit: nurpax

This is the third dispatch from Eleanor Coates, who is spending every day this month interviewing FINCA/Zambia clients as part of FINCA’s client survey process. For more from the field, be sure to read her first and second posts here.

I recognize that the microfinance industry has been ingenious, as a whole, at using incentives to reduce risk and moral hazard. FINCA uses village banks to provide social incentives for people to repay their loans in a timely manner, responding to the pressure of their friends and group members. They also use the groups to monitor client businesses, to ensure that the clients are engaging in entrepreneurial activities rather than using their loans for other purchases, such as consumer goods. Clients have the incentive to watch out for each other, to work together and to collaborate in their efforts to build up their businesses in order to not only repay their loans, but to ensure that they will be able to get larger loans in the future. FINCA has been able to structure the incentives for the village banks such that repayment rates stay high, allowing FINCA to continue functioning with interest rates which, according to many clients, are lower than most. However, there are other incentives at work in the relationship between the clients.

FINCA Zambia has both a social and a financial mission – to help the poorest entrepreneurs have access to loans, create businesses and jobs, and to be a commercially solvent and sustainable microfinance institution. FINCA clients, as we have seen through many client interviews, are well aware of the consequences of delinquency in their loans. But some people tell us that their loan officers are too strict when it comes to paying back their loans – that if they could only have some allowances it would be better for them. Loan officers have incentives not to make too many allowances for clients, while still earning and maintaining their trust. They face a delicate situation. While at first, FINCA’s strict insistence, as reflected in its loan officer incentive structure, seems at odds with its social mission, failed endeavors into microfinance by organizations who were not strong enough in their institutional incentives to collect loans show that the pressure that FINCA applies to its loan officers to collect loans from their clients is well founded. Without strong incentives, even with perfectly well-intentioned clients who will pay back, the logistics of exceptions would increase costs and interest rates, making loans affordable to fewer people. So while the incentive structures for loan officers do serve to create some tension between them and their clients, that tension is a necessary component of making microfinance work.