SEEP Frame Update -Draft for Review 7-2-09

8/8/2019 SEEP Frame Update -Draft for Review 7-2-09

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Financial Services Working Group

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Update of Key Ratios to the SEEP Framework

Draft for Review - July 2 2009

Summary Overview:

The following eight (8) new ratios have been selected as an update to the 18 core ratios listed in the 2005

publication of SEEP’s Measuring Performance of Microfinance Institutions: A Framework for Reporting,

Analysis and Monitoring. This is an initial working draft for review and comment by SEEP Financial

Services Working Group members. The end objective is to reach consensus on an updated set of ratios

and release a “second edition” of the SEEP publication as well as an update to the Frame reporting tool.

Please note that the page numbers refer to the 2005 SEEP manual, also attached for reference or availablefor download on the SEEP website here: http://www.seepnetwork.org/Pages/Frame.aspx.

To be included in Table 4.1 Summary of the SEEP 18 (page 66):

To be included in Section 4.2 Asset/Liability Management Ratios (page 71):

R8 Capital Adequacy Ratio

Why This Ratio Is Important

Term Formula Explanation

Total Equity

Total Assets - Cash and due from banks

Total CapitalRisk Weighted Assets

PAR>30 days - Impairment Loss Allowance

Total Equity

PAR>30 days - Impairment Loss Allowance

Total Capital

This ratio is a measure of the solvency of the MFI.

It helps asses its ability to meet its obligations

and absorb unexpected losses. The adjusted

ratio, called the Capital Adequacy Ratio (CAR)

measures more accurately (and in line with Basel

II calculations) the amount of capital and the risk

level of assets. Thus, it becomes a betterindicator of the solvency of the MFI to meet its

obligations and absorb unexpected losses.

Indicates how the MFI is managing its level of risk

relative to the amount of capital it has. The lower

the ratio the better. The adjusted ratio includes a

better assesment of the capital that the MFI has

to cover potential losses derived from the

deterioriation of the PAR that has not been

provisioned.

Adjusted Uncovered Capital

Ratio (UCR)

R8

R9 Uncovered Capital Ratio (UCR)

Capital Adequacy Ratio (CAR)

Asset/Liability Management

Equity to Assets

Total Equity B32

Total Assets - Cash and due from Banks B12 - B1Equity to Assets =

http://www.seepnetwork.org/Pages/Frame.aspx







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The Equity to Assets ratio is a simple measure of the institution’s solvency. It indicates the amount of

capital that an MFI has to cushion against future losses and ensure it is able to cover its expenses and

obligations over the long-term. It can also provide a relative indication of how well capitalized aninstitution is in comparison to its peers.

The amount of capital required is generally based on the MFI’s own assessment of expected losses and its

financial strength to absorb unexpected losses. Expected losses should generally be covered through

provisions by the company’s accounting policies which remove expected losses from both assets and

equity. Thus the ratio measures the amount of capital required to cover additional unexpected losses to

ensure that the MFI is well capitalized for potential shocks.

Effect of the Adjustments (according to Basel Accord)

The Capital Adequacy Ratio (CAR) adjusts the Equity to Assets ratio both in the numerator and the

denominator. Total Equity is adjusted as per Basel Accord guidelines and allows the inclusion of

supplementary capital such as general loan loss reserves, asset revaluation reserves and subordinated debt.

It also deducts goodwill to provide a more tangible measure of total capital.

For assets, the adjustment weights assets by their level of risk, acknowledging that some financial assets

are inherently less risky and require less capital to be reserved for unexpected losses. The adjustment also

considers off-balance sheet commitments which currently benefit the institution but may generate future

liabilities and thus require that certain capital be reserved.

As mentioned before, the amount of capital required is generally based on the MFI’s own assessment of

expected losses and its financial strength to absorb unexpected losses. One definition of unexpected loss

is the worst-case financial loss or impact that a business could incur due to a particular loss or risk. Such

losses are typically not projected to occur during the normal course of business and can arise from either

risks inherent in the business of the institution or from external factors. Internal factors might include the

type of lending performed (i.e., crop loans constituting a higher probability of default than group loans),

the collateral held against potential loan portfolio losses or diversification of operations (by geography,

revenue source, etc.). External factors might include weather-related shocks, political crises or economic

shocks such as high inflation or bank failures.

The best way for an institution to anticipate unexpected losses is to assess previous experience, either

internally or externally, with unexpected losses suffered by engaging in a similar type of business activity

or operating in a similar type of environmental, economic, political, business and context. All of these

Total Capital B32 ADJ

Risk Weighted Assets B12 ADJ (RWA )

Capital Adequacy

Ratio (CAR) =




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elements must be taken into account when selecting an appropriate target level of the Capital Adequacy

Ratio.

To be included in Chapter 3 on Analytical Adjustments (page 53):

3.7 Capital Adjustments

Total Capital should be formed by Tier 1 and Tier 2 Capital (defined below) taking into account the

limits and restrictions as well as the deductions mentioned below:

Donated Equity should be earned in order to be considered as Capital. Unearned donations should be held

as liabilities.

Definitions: The following definitions are taken from the Basel Accord. They should be included in the

appendix of the document.

(i) Undisclosed reserves: Unpublished or hidden reserves may be constituted in various waysaccording to differing legal and accounting regimes in member countries. Under this heading are

included only reserves which, though unpublished, have been passed through the profit and loss account and which are accepted by the bank’s supervisory authorities. They may be inherently of

the same intrinsic quality as published retained earnings, but, in the context of an internationally

agreed minimum standard, their lack of transparency, together with the fact that many countries

do not recognize undisclosed reserves, either as an accepted accounting concept or as a legitimate

element of capital, argue for excluding them from the core equity capital element.

(ii) Revaluation reserves: Some countries, under their national regulatory or accounting

arrangements, allow certain assets to be revalued to reflect their current value, or somethingcloser to their current value than historic cost, and the resultant revaluation reserves to beincluded in the capital base. Such reserves may be included within Tier 2 capital provided that

the assets are considered by the supervisory authority to be prudently valued, fully reflecting the

possibility of price fluctuations and forced sale. A discount of 55% on the difference between the

historic cost book value and market value is agreed to be appropriate in the light of these

considerations.

Tier 1 Capital Tier 2 Capital

Paid-in Capital B22 Undisclosed reserves See definition

Donated Equity B23 Asset revaluation reserves B30

Retained Earnings B26 General loan-loss reserves See definition

Disclosed Reserves B29 Hybrid (debt/equity) capital instruments See definition

Subordinated debt See definition




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(iii) General loan-loss reserves: General loan-loss reserves are created against the possibility of

losses not yet identified. Where they do not reflect a known deterioration in the valuation of

particular assets, these reserves qualify for inclusion in tier 2 capital. Where, however, provisionsor reserves have been created against identified losses or in respect of an identified deterioration

in the value of any asset or group of subsets of assets, they are not freely available to meet

unidentified losses which may subsequently arise elsewhere in the portfolio and do not possess

an essential characteristic of capital. Such provisions or reserves should therefore not be included

in the capital base.

(iv) Hybrid debt capital instruments: In this category fall a number of capital instruments which

combine certain characteristics of equity and certain characteristics of debt. Each of these has

particular features which can be considered to affect its quality as capital. It has been agreed that,

where these instruments have close similarities to equity, in particular when they are able to

support losses on an on-going basis without triggering liquidation, they may be included in

supplementary capital.

(v) Subordinated term debt: Basel II is agreed that subordinated term debt instruments have

significant deficiencies as constituents of capital in view of their fixed maturity and inability to

absorb losses except in a liquidation. These deficiencies justify an additional restriction on the amount of such debt capital which is eligible for inclusion within the capital base. Consequently,

it has been concluded that subordinated term debt instruments with a minimum original term to

maturity of over five years may be included within the supplementary elements of capital, but

only to a maximum of 50% of the core capital element and subject to adequate amortization

arrangements.

The sum of tier 1 and tier 2 elements will be eligible for inclusion in the Total Capital Calculation, subjectto the following limits and deductions:

- The total of tier 2 (supplementary) elements will be limited to a maximum of 100% of the total of

tier 1 elements;

- subordinated term debt will be limited to a maximum of 50% of tier 1 elements;

- general loan-loss reserves are limited to a maximum of 1.25 % of the portfolio;

- asset revaluation reserves which take the form of unrealized gains on securities will be subject to

a discount of 55%;

- goodwill assets are removed from Capital at 100% of current value

3.8 Risk Weighted Assets According to Basel II Accord

The rationale behind Basel II Accord is that financial institutions should have capital that protects from

potential losses that derive from the risk associated of each asset type held by the financial institution. The

Basel II Accord provides with a Standard Approach to calculate risk-weighted assets (RWA). This

approach considers the credit rating of an asset type a good indicator of its level of risk.




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For a Microfinance Institution, we have used the rationale behind Basel II to assess the risk level for any

investment made by the MFI. For the entire loan portfolio and other less liquid assets we have applied a

100% risk weight. In addition this calculation will also include off-balance sheet/contingent liabilities.The following table summarized the RWA calculation for an MFI:

Trade Investments & Other Investments

For Microfinance Institutions, the RWA calculation for the investments account will follow theSimplified Standard Approach Framework from the Basel II Accord for financial assets issued by

sovereign countries, Central Banks, Multilateral Organizations, Banks, securities firms, corporations,

insurance companies and off balance sheet items.

For financial assets issued by sovereign countries and/or banks and securities firms, the risk weight is

based on the consensus country risk scores of export credit agencies (ECA) and is available on the OECD

website. For exposures with banks and securities firms that are regulated entities, the risk weight is

assigned one category below the country in which they are incorporated. The following table summarizes

the risk weight for both categories. It is important to mention that a cap of 100% has been applied the

riskiest exposures, though the Standard Approach suggests 150% risk weight.1

For financial assets issued by multilateral organizations the issuer will be eligible for a 0% risk weight if

it is mentioned below, otherwise it will receive a 100% risk weight.

- Bank of International Settlements (BIS)

- International Monetary Fund (IMF)

- European Central Bank (ECB)

1 It is important to mention that we put a cap of 100% for the riskier exposures, though the Standard Approach suggests 150%

risk weight. The Basel Accords apply a risk weighting higher than 100% because they are requiring that more capital be held inreserve against future losses relative to those assets. Since the benchmark Capital Adequacy Ratio for banks is fixed at 8%,regulators must assign a risk weight above 100% if they feel 8% is inadequate. A 150% risk weight would mean that 12% capital

is required to be reserved against those assets (8% * 1.5 = 12%). Since no such global benchmark exists for MFIs, the maximumrisk weight was kept to 100%, and MFIs are encouraged to set their own benchmark Capital Adequacy Ratio, which in mostcases is likely to be significantly higher than the 8% benchmark for banks.

Type of Assets Risk Weight Ref

Cash and Due from Banks (less than a week) 0% B1

Trade Investments & Other Investments See Table B2 & B8

Loan Portfolio (net of specific provisions) 100% B3 & B6

Other Assets 100% B7 & B10

Off Balance sheet items See Table N/A

Issuer 0-1 2 3 4 to 6 7

Sovereign 0% 20% 50% 100% 100%

Banks and securities firms 20% 50% 100% 100% 100%

OECD Classification




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- European Community (EC)

- World Bank Group, including the International Bank for Reconstruction and Development

(IBRD), and the International Finance Corporation (IFC).- Asian Development Bank (ADB)

- African Development Bank (AfDB)

- European Bank for Reconstruction and Development (EBRD)

- European Investment Fund (EIF)

- The Nordic Investment Bank (NIB)

- The Caribbean Development Bank (CDB)

- The Islamic Development Bank (IDB), and

- The Council of Europe Development Bank (CEDB).

For financial assets issued by corporations and insurance companies the risk weight will be 100%.

For off balance sheet/ contingent liabilities, the value of the commitment issued by the MFI will be

added as an asset at the following rates based on original maturity.

The following example shows how this calculation should be made.

Off balance sheet commitments Risk Weight

Short term ( < 1 year original maturity) 20%

Long term ( > 1 year original maturity) 50%

Ref Account Name Risk Weight As of 12/31/2004 Risk Weighted Assets

B1 Cash and Due from Banks 0% 3,261,195 -

B2 Trade Investments See Table below 10,611,928 6,663,742

B3 Net Loan Portfolio 100% 54,338,636 54,338,636 B6 Interest Receivable on Loan Portfolio 100% 1,604,993 1,604,993

B7 Accounts Receivable and Other Assets 100% 1,610,308 1,610,308

B8 Other Investments See Table below 1,165,420 582,710

B9 Net Fixed Assets 100% 5,567,936 5,567,936

Off Balance Sheet Items

Short term Guarantee 20% 2,000,000 400,000

B12 Total Risk Weighted Assets (RWA) 78,160,416 70,368,325

Example of Trade Investments and Other Investments of a OECD Risk 3 Country

B2 Trade Investments Risk Weight As of 12/31/2004 Risk Weighted Assets

Short Term placements with Domestic Banks 100% 2,715,555 2,715,555

Stock of a Foreign Bank (OECD 2) 50% 7,896,373 3,948,187

B2 Total Trade Investments 10,611,928 6,663,742

B8 Other Investments Risk Weight As of 12/31/2004 Risk Weighted Assets

Long term domestic government bonds 50% 1,165,420 582,710

B8 Total OTher Investments 1,165,420 582,710




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To be included in Section 4.2 Calculating the SEEP 18:

R9 Uncovered Capital Ratio

Why This Ratio Is Important?

As mentioned before, intuitively the amount of capital required by an institution should cover unexpected

losses and provisions should cover expected losses. The Uncovered Capital Ratio (UCR) indicates the

percentage of capital held to cover losses which may be subject a higher level of risk but for which

potential losses have not been provisioned for as expected losses. Most types of risks discussed above

which may lead to unexpected losses are longer-term in nature, and thus an MFI can set a longer-term

policy with respect to a targeted Capital Adequacy ratio. By contrast, portfolio quality can change quickly

and have a significant impact on solvency, so this ratio focuses specifically on this particular risk. The

ratio measures the amount of Capital which may be at an elevated risk of unexpected losses as measuredby PAR > 30 days which has not been provisioned.

A lower ratio (such as 25% or lower) indicates that the institution’s capital is at a lower level of risk from

potential losses. Risk of capital loss increases as the value of the ration increases. Alternatively, a

negative ratio would suggest that the Capital Adequacy Ratio may be conservatively understated and that

PAR>30 days - Impairment Loss Allowance P14 > 30 days – A5

otal Equity B32 UCR =

Ref. Account Name As of

31/12/2004 As of

31/12/2003

B32

B12-B1

Capital

RWA

P14 > 30 days – A5

B32

P14 > 30 days – A5

Capital

ADJ

Adjusted UCR R9 = 1.59% 2.28%

62.0%

2.28%

Equity to Assets Ratio

Uncovered Capital Ratio

R8 =

R9 =

Capital Adequacy Ratio R8 = 68.1% 73.6%

Formula

R8

R9

64.0%

1.59%

ADJ




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the institution may have additional capital available to cushion against other types of losses even under a

worst-case scenario of loan defaults based upon current portfolio quality.

Effect of the Adjustments (according to Basel Accord)

The adjusted ratio has the same use as the UCR, but should be used in conjunction with the Capital

Adequacy Ratio for consistency purposes.

R10 Ratio on foreign currency risk

(This ratio will require additional disclosures for each foreign currency [A to Z] on the MFI’s balance

sheet. MFIs will have to separately report their total assets and total liabilities in each of those

currencies.)

Why this ratio is important

This indicator provides information about the institution’s exposure to foreign currency. The ratio of

foreign currency open position to total equity should be no more than 10% - 20 %. If the FX gap is

greater than 10%-20% of total equity, then the institution could face a liquidity crisis or insolvency if

foreign exchange markets move significantly — a risk the institution cannot control. This is particularly

concerning for institutions that are mobilizing customer deposits.

To be included in a new Section [4.5] Savings Ratios (after page 85):

Should this be a new section or inserted in ALM?

R22 Average deposits balance per Deposit accounts (or it could be divided per Depositors, please give your feedback on that )

Absolute Value (Total Foreign Currency A Assets – (Total

Foreign Currency A Liabilities)

Absolute Value (Total Foreign Currency A Assets – Total

Foreign Currency A Liabilities)

Total Equity B32

Foreign Currency A

Open Position per

total equity

PAR>30 days - Impairment Loss Allowance P14 > 30 days – A5

otal Capital Capital Adjusted UCR =




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This indicator provides information on the level of target clientele trust and the efficiency of the range of

savings products in responding to client needs. This ratio gives an indication of the target population that

the MFI reached considering its mission and objectives.

Managers should look closely at the trend of this ratio overtime. This ratio should see a positive trend in

this ratio since the goal of the MFI is to increase the services delivered. However, managers should

analyze the reasons behind a drop of this ratio. It could indicate a loss in confidence from the clients, an

increase in membership, a change in the target population or large deposit withdrawals due to a specific

event.

Each MFI should set its own optimal objective and it should be based on the MFI’s business plan and

mission. If the MFI is growing quickly, managers may want to use period averages for the denominator.

MFIs may also substitute Number of Depositors as a surrogate for Number of Deposit Accounts provided

that they explain the definition of the numerator and denominator.

Effects of adjustments

None of the adjustments proposed in the Framework affect the liquid ratio.

R23 Yield on liquidity and investments


This ratio indicates the return that the MFI generates from its average cash and investments during the

period. It measures the efficiency of the institution to manage its liquidity and investments. The objective

Total deposits B13 + B14 +B18

Number of Deposit Accounts N5

Average deposits balance

per Deposit accounts =

Financial Revenue from investments I5

Average Cash + Average Trade Investments + Average Other Investments B1 ave + B2 ave + B8 ave

Yield on liquidity and

investments =




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is to maximize the return on investments restricted to respect liquidity standards, to match with the

liabilities and to diminish the various risks involved in the liquidity management. Nevertheless, the

revenue from investment activities should demonstrate some stability and be in accordance with thebudgeting projections. Comparison with market benchmarks can reveal the ability of the institution to get

revenues from its liquidity and investments.

This ratio should be part of a liquidity and investment policy which sets the framework and guidelines

overseeing liquidity activities in MFIs. The policy should at least define liquidity standards and limits in

order to secure deposits of members and answer to the need of funds.

The yield on liquidity and investments depends on the market and will therefore vary by country. In

addition to compare this ratio with market benchmarks, a manager can compare this ratio with the Cost of

Funds (R6). Managers should maintain a sufficient yield on liquidity and investments in regards to the

Cost of Funds of the MFI.

Effects of adjustments

None of the adjustments proposed in the Framework affect the liquid ratio.

R24 Ratio on Savings Liquidity (This ratio will require some items from the sub-account: restricted cash other than Required Reserves

and Undrawn Portion of committed credit lines.)


This indicator provides information on the cash available to meet withdrawals in demand deposits

accounts. Generally the regulator will require a statutory reserve against demand deposits, but if not, the

institution should ensure that an adequate amount of cash is available to cover possible withdrawals.

If cash is not available to meet large-scale withdrawals (possibly either due to seasonality or due to loss of confidence in the institution), then the institution could run into liquidity problems which could quickly

escalate into insolvency.

R25 Effective financial expense of savings

Reserves against deposits as required by regulator plus

unrestricted cash + undrawn portion

B1 – restricted cash other than required by regulator against

deposits + undrawn portion of committed credit lines

Total Demand Deposits B13

Liquid Assets / Total

Demand Deposits




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This indicator is important to provide a sense of how the financial expense of the deposit program

compares to borrowing opportunities in the market. Given the complexities of deposit mobilization, an

institution should ensure that it provides the most cost-effective liabilities in its capital structure.

R26 Effective Operating Expense of Savings


This ratio is important to ensure that the gain on deposit mobilization (through cost-effective financing)

compensates the institution for the cost of administering the program. If the cost of the program is too

high (i.e. cost per Unit of savings mobilized PLUS effective financial expense of savings > cost of short

term borrowings,) then the institution should consider replacing deposits with cheaper short-term

borrowings

This ratio can also provide a guide to an MFI about how to price its savings products. The effective

financial expense of savings (or average interest rate paid on savings) should be lowered if financial

expense plus operating expense is greater than the cost of other forms of liabilities or equity. From a

profitability perspective, deposits should be the most cost-effective form of liabilities in order to justify

the expense of maintaining the deposit program.

Total interest expense of savings I19

Average savings balance Average (B13+B14+B18)

Financial Expense of

Savings Mobilized

Direct and Indirect Operating expenses allocated to savings (I17a+I18a+I20a)

Average Savings Balance Average (B13+B14+B18)

Cost per Unit of

Savings Mobilized




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Summary of SEEP 18 Expanded Ratios (8 new ratios for total 26):

R1 OSS

R2 ROA

R3 ROE

R4 Yield on Gross Portfolio

R5 Portfolio to Assets

R6 COF

R7 D/E

R8 Capital Adequacy (formerly Liquid Ratio)

R9 Uncovered Capital Ratio (formerly PAR)

R10 Foreign Currency Risk (formerly Write Off)

R11 Risk Coverage Ratio

R12 Operating Expense

R13 Cost per Client

R14 Borrower per Loan Officer

R15 Clients per Staff

R16 Turnover

R17 Average Loan Size

R18 Average Disbursement Size

R19 (Shift R8 to starting at R11)

R20 (Shift down)

R21 (Shift down)

R22 Average Deposit Balance per Deposit Account

R23 Yield on Liquidity and Investments

R24 Ratio on Savings Liquidity

R25 Effective Financial Expense of Savings

R26 Effective Operating Expense of Savings

SEEP Frame Update -Draft for Review 7-2-09

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