Henk A.J. Moll
Wageningen Agricultural University
Department of Development Economics

August 1996


1. Introduction

Many donor-supported projects in developing countries provide credit to small farmers or small-scale entrepreneurs. The donors generally stipulate regular evaluations of the progress made in these projects. This article describes a method for the first stage of evaluating credit projects or credit components in projects: it results in a distinction between potentially good projects and poor performers and it provides a focus for a subsequent detailed evaluation.

It is only possible to evaluate projects if objectives have been formulated, so this evaluation method assumes that the project has at least two objectives: a) credit operations that are financially viable, and b) the provision of services that are useful (Moll, 1994 and Yaron, 1992). These objectives may be worded differently, i.e. 'revolving fund' may be used to indicate that the activity should be continuous (and thus necessarily financially viable), or the phrase 'fulfilment of a real credit need' may be used to indicate the required usefulness to clients. If these two objectives are not applicable to a particular credit project, the evaluation method is not applicable. In such a case, however, the reason for providing credit should be urgently reviewed.

The evaluation method is outlined below. The background to the approach followed is explained in section 3.

2 The pre-evaluation

The evaluation consists of collecting data via three questions and then interpreting the answers, individually and collectively. The questions have been phrased so that they elicit an unambiguous 'yes' or 'no', with 'yes' pointing to a positive judgment and 'no' to a negative one.

2.1 Three questions and the interpretation of the answers.

2.2 Score and interpretation

The total score ranges from three times 'yes', a rating of 3, to three times 'no', a rating of 0. The intermediate ratings of 1 and 2 each have three different combinations of 'yes' and 'no' answers.

A score of 3 indicates that the project possibly achieves the two stated objectives, or may achieve them in future. The availability of data and the positive indications shown by the answers to questions two and three justify a detailed subsequent evaluation.

A credit project with a score of 0 must be considered hopeless: the project is loss making, but the scope of these losses cannot be established because reliable data are missing; moreover, the credit services provided are ill-adjusted to the borrowers. No further evaluation is warranted, and the three options are to terminate the project directly, to discontinue the provision of funds (which means termination within a couple of years), or to continue funding an unviable operation. None of these options is attractive, but the project has no prospects of attaining the two stated objectives.

Projects with a score of 2 might have the potential to achieve the objectives in future. A brief investigation is required to establish the possibilities of changing the one 'no' answer into a 'yes'. It is relatively easy to upgrade a reasonable administrative system to a level that allows external auditing. More drastic modifications are required to change the lending rate from negative in real terms to the 20 percent or more which is generally required to reach financial viability, or to change the lending procedures to suit individual capabilities and requirements. Drastic or less drastic modifications are thus required to achieve the two stated objectives.

A score of 1 indicates serious defects in organisation, operations, or both. A brief assessment of the defects should be undertaken to determine whether or not it is feasible to fundamentally re-adjust the project.

3 Discussion

3.1 Background to the three questions

The first question probes into the governance structure by focusing on two aspects:

the existence of an appropriate financial reporting system and the presence of independent external control of the financial operations. Both aspects are especially relevant for credit projects because the management and control structure of such projects is more complicated than in other projects, such as those dealing with training or extension. The latter activities merely require annual budgets and it is generally sufficient to record recurrent and capital expenditure. When providing credit, however, the stock and flow of funds must be reported: the balance sheet and the statement of income and expenditure, respectively. Without these financial reports neither project staff nor supporting agency have insight into the financial performance, and the project operates without a financial rudder. The importance of external control lies in the technicalities of financial reporting and the incentive structure within which project staff operate. The pressure to produce measurable results within a relatively short period may induce staff to interpret loan evaluation rules liberally to obtain results, a large portfolio. The penalties incurred by doing this are lower loan recoveries and honest borrowers being unnecessarily turned into defaulters. Knowing that administration and procedures will be checked annually by outsiders is an important incentive to make project staff adhere strictly to agreed policy. The first question thus establishes whether or not the project organisation and donor agency have recognised the specific nature of credit projects and have established appropriate management and control mechanisms.

The second question focuses on financial viability, and the conclusion 'non viable' when the answer is 'no' leaves little room for discussion. One might argue - justifiably - that if in the future the inflation rate falls, the project's financial situation will improve.

However, even at a low, one-digit inflation rate, a typical project lending rate of say ten to fifteen percent will not result in viable credit operations. Therefore, only if the answer is 'yes' does the real question regarding financial viability become appropriate: is the lending rate sufficiently above inflation to cover recurrent expenditure, capital cost, and losses resulting from default. That question can be answered if accurate financial data are available and, in the second place, if additional investigations are made into the loan portfolio and possibly into implicit donor subsidies through staff secondment or capital provided at concessionary interest rates. (see Yaron, 1994, for a discussion of the implicit subsidy index).

The last question refers to the project's approach towards the potential borrowers. Two extreme approaches can be distinguished. One starts with the conviction that application of a certain technology or enterprise will be advantageous for a certain group of people. 'Lack of capital' is further identified as a major constraint to such application; generally the group of potential beneficiaries such as farmers, saleswomen, or small entrepreneurs is described as being 'poor'. The project then takes the initiative to solve this financial constraint by providing credit, often by providing the requirements for the technology or enterprise in kind (see Von Pischke, 1981, for an analysis of the political motives behind this type of credit programmes). In such an approach the emphasis is on the distribution and acceptance of technology or enterprise, and credit is seen as a means to facilitate the acceptance. As a result, insufficient attention is likely to be paid to the financial viability of the credit operations, and the clients' needs for financing - other than those required for the specified purpose - are disregarded. In the extreme form indicated, this approach offers few prospects for reaching the two stated objectives of credit projects.

In the second approach the provision of credit is considered a useful service for people currently without access to institutional financial services. The clients' financing requirements are central and the credit products are designed to meet existing demand and financial capabilities. The emphasis is on establishing long term relationships on the basis of the reputation of the borrowers. This approach requires a focus related to both stated objectives: financial viability of the credit operations to enable continuation of the services, and flexibility in lending to satisfy individual requirements.

Taken together the three questions delineate the 'feasible area': a project with three 'yes' answers lies within this area. Projects with one or more 'no' answers lie outside the feasible area and are highly unlikely to achieve the two objectives.

3.2 Reliability

An evaluation using three questions that can be discussed and answered in ten minutes raises questions about the reliability of the results. Two remarks are in order here: the first one to justify the questions as such, and the second one to put the score in the correct perspective.

The questions have been selected to investigate three main fields in the provision of credit: the external control mechanism of project and donor; the internal financial operations of the project as an enterprise; and, the project's attitude towards the borrowers. They have been phrased to elicit clear judgment via a 'yes' or 'no': if externally audited financial statements are present it is quite certain that the financial reports reflect the actual situation; if the lending rate is below the inflation rate it is certain that the project is loss-making; if loans are adjusted to individual requirements the project must have paid attention to the borrowers, and this is a basic aspect of sound provision of financial services. Given the assumed two objectives of credit projects, the scope and the phrasing of three questions lead to a valuable qualitative insight into the project.

Care must be taken when converting the three answers into one quantitative score from 0 to 3, as there are variations in the meanings of the 'yes' answers as well as in the 'no' answers. To acknowledge this variation an error factor of plus or minus 0.5 must be added to the score obtained for an individual project. With such an error factor the interpretation of the score becomes somewhat different: a) a group of projects with a score of 3 clearly outperforms a group of projects with a score of 2; b) an individual project with a score of 2 might perform equally well as an individual project with a score of 3, although this is unlikely; c) projects with a score of 3 or 2 are always superior to projects with a score of 1 or 0 respectively.

Finally, the method is a pre-evaluation and thus does not provide definite answers. However, spending ten minutes doing the test, and a little longer reflecting on the test and the results will probably prove to be a worthwhile investment at the start of evaluating a particular credit project.


Adams, D.W. and J.D. Von Pischke (1992) 'Microenterprise Credit programs: deja vu' World Development 20(10): 1463-70.

Moll, H.A.J. (1994) 'The performance of banks in rural financial markets', in F.J.A. Bouman and O. Hospes (eds) 'Financial landscapes reconstructed: the fine art of mapping development' Westview Press, Boulder.

Yaron, J. (1992) 'Successful rural finance institutions', World Bank, Washington D.C.

Von Pischke, J.D. (1981) 'The political economy of specialized farm credit institutions in low-income countries', World Bank Staff Working paper no. 466, World Bank, Washington D.C.

Author's contact address:
Henk A.J. Moll
Hollandseweg 1
6706 KN Wageningen
phone 31 317 484354
fax 31 317 484037

Hari Srinivas -
Return to the Microfinance Governance Page
Return to the Virtual Library on Microcredit