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Designing Financial Incentives to Increase Loan Officer Productivity:
Handle With Care!
Martin Holtmann

Efficiency in micro and small business lending is credit operation, loan officers possess vastly more
arguably the strongest single driver of financial detailed and accurate information about the local
performance. This realization has increasingly environment and the clients than do central
been reflected in the microfinance literature. In management and the owners. In the presence of
February 2000, the MicroBanking Bulletin dedicated such information asymmetries and high monitoring
a whole issue to the topic of efficiency. More costs, managers are well advised to align the goals
significantly, during the last decade, a number of of the institution (which usually include a mix of
lending institutions have made significant outreach and profitability indicators) with those of
improvements in their operating efficiency. the agents who actually make the vast majority of
operational decisions. Again, well-designed incen-
One aspect of efficiency is the productivity of staff tives can be useful in achieving this goal.
members. This article takes a closer look at the
contribution that one specific toolloan officer
incentive schemescan make to improving produc- Design and Typology of Incentive
tivity. It also makes some suggestions for the Schemes
design and implementation of such schemes. As a As the basis for designing an incentive scheme, the
reflection of the authors limited experience with loan officers duties must first be clearly defined,
group lending, all examples are from individual loan and they should be derived from the goals of the
programs. However, most of the findings of this lending institution. This yields a range of targets
article should also be applicable to group lenders. that the loan officer is supposed to meet. Typical
examples include:
Why Focus on Loan Officer Productivity? Number and volume of loans issued;
In microfinance institutions (MFIs), loan officers are Number and volume of outstanding loans;
responsible for creating and safeguarding the 2
quality of the assets (i.e. the size and arrears rate of Number of loans to first-time customers;
the loan portfolio) as well as for generating the Quality of the loan officers portfolio (in the form
income (i.e. interest payments from clients) for the of the lowest feasible portfolio-at-risk rate).
institution. In addition, since they are the point of
contact with clients, the work of the loan officers Most incentive schemes consist of some or all of
has an enormous impact on an institutions these variables. The individual components must
outreach. In a nutshell, the loan officers are the be weighted to ensure that the goals pursued by
agents that produce an MFIs output. loan officers match the institutions goals as closely
as possible. It is impossible to achieve a perfect
On the input side of the equation, loan officers match between the goals of loan officers and those
account for a significant share of staff costs, which of the institution. Also, outreach, credit volume and
in turn accounts for a significant portion (50 to 70 portfolio quality cannot be maximized simultan-
percent) of administrative expenses. Clearly, a eously. When putting together an incentive pack-
production factor that accounts for most of the age that gives due consideration to all three factors,
costs and generates almost all of the output and achieving the optimal mix of the three variables
income should be given incentives to become as inevitably involves certain trade-offs.
productive as possible! Financial incentives can
enhance employee performance and productivity in
microfinance just as in other industries.
A second argument supporting the design and Since lending to existing customers involves less processing
and analytical effort than lending to new customers, experienced
implementation of loan officer incentives is the loan officers with a large pool of customers tend to focus on their
highly decentralized structure of the decision-mak- existing clients. This type of behavior is clearly contrary to the
ing and credit delivery process. In a typical micro- MFIs outreach objectives.



While loan officers make the most important Loan officer incentive schemes introduced in
contribution to reaching the output goals, numerous several downscaling programs in Eastern Europe
factors, such as external economic shocks or typically gave a boost to loan officer productivity.
devaluation, are outside their control. Furthermore, The performance of loan officers of the Russian
loan officers basic living expenses must be covered State Savings Bank is significantly better in
to ensure that they will be willing to take appropriate branches that allowed the implementation of an
risks in the course of their work. Given these two incentive system than in branches that opted to
points, loan officers should not only receive a per- maintain a fixed salary. In the Siberian city of
formance-related bonus, but should also receive a Krasnoyarsk, for instance, introduction of incentives
fixed basic salary. led to positive productivity differentials of more than
30 percent. In Kazakstan, incentives have been
Regarding the weighting between bonuses and introduced in all the banks participating in the
salary, the general rule is that a bonus of less than European Bank for Reconstruction and
20 percent of total remuneration does not create Developments small business program, and the
significant stimulus to improve performance. Con- effect on productivity has been quite strong.
versely, a bonus of more than 70 percent of the
remuneration package will attract loan officers who When a re-designed financial incentive system was
are active risk seekers. In practice, the share of the introduced at FEFAD Bank in Albania in early 2000,
performance-based bonus in overall compensation loan officer productivity (measured in average
is best if it is between 30 and 50 percent. number of loans disbursed per loan officer per
month) increased by more than 100 percent within
Financial incentive schemes vary in complexity. a period of five months, while the portfolio-at-risk
The simplest form is the piece rate system, in which ratio remained at the same low level as before.
the loan officer receives a set bonus per unit of
output. Multiplying the figures for the indicators in
question (e.g. number of loans issued to new cus- Words of Caution
tomers) by the respective set amount yields the Design and implementation of loan officer bonus
total bonus. To discourage delinquency, a penalty systems requires careful planning. One obvious
can be deducted based on arrears. challenge is to ensure that the incentives are
properly aligned with the goals of the organization.
Complex bonus systems allow management to set Misalignments can be avoided by testing the
targets for loan officers in regard to specific vari- system during the design phase, both through
ables. Such systems have the advantage of being spreadsheet calculations and a limited field test
oriented to the performance values of the institution (e.g. in a branch office).
as a whole, and therefore also allow fine-tuning.
The effectiveness of incentive systems depends on
the cultural environment in which a microfinance
Impact of Financial Incentive Systems: institution operates. Timing is another critical issue.
Some Empirical Evidence It is useful to phase in an incentive system
There is ample empirical evidence that the intro- gradually. During their training period, loan officers
duction of loan officer incentive schemes can make need to make mistakes in order to learn from them,
positive contributions to loan officer efficiency. thus they should not be penalized. Later on, as the
Some of the most efficient Latin American MFIs whole organization moves up the learning curve
with very high loan officer productivity use financial (i.e. average loan officer productivity increases) the
incentive systems, including WWB Cali, Financiera bonus system can be adjusted. The introduction of
Calpi, CMAC, Banco ADEMI, and Caja Los Andes. new products also requires changes to the bonus
system. Implementation of a bonus system at the
The BRI Unit Desa, a high productivity lender in loan officer level usually generates the need for
Indonesia, uses a profit bonus system (based on incentive systems at other layers of the organization
unit performance) to motivate staff. In addition, (department heads, branch managers, etc.).
there is a semi-annual contest for cash prizes.
The empirical observation that many systems have
produced completely unwanted effects leads to the
conclusion that it is better not to have an incentive
system than to have one that is badly designed.
Based on MicroFinance Training Program, Boulder, Colorado,
course notes by Richard M. Hook. Pure profit-sharing schemes
at the loan officer level generally work well in small groups where
potential free riders can be sanctioned. For larger groups, this Spreadsheet calculations also help to calibrate the impact that
self-regulating mechanism usually does not work and the system will have on the cost of lending operations and to
performance should be measured individually. forecast the break-even point.



A bonus system for loan officers is only one part of The bonus is derived as:
a productivity-focused lending technology. Other, Bonus = L + P + A
and probably more important elements are: stan-
dardization of products and procedures, decentral-
ization, effective screening of clients to reduce
L = Lending (number of loans disbursed to new
dropout rates during analysis, and effective use of
and repeat clients)
MIS. Furthermore, compiling and posting individual
P = Portfolio (number of loans and balance
and branch rankings creates a healthy spirit of
competitionwith the corresponding positive
A = Arrears (number of loans and portfolio at
impact on productivity. 8
What conclusions may be drawn? There is strong
The variables create a ratio of actual results to
evidence that a well-designed monetary incentive
intended targets. Additionally, weights are applied
system for lending staff does indeed boost
to the variables, and for each part of the formula a
productivity. But a bonus system is only part of an
bonus factor is given. The sum of the bonus factors
overall culture of high productivity. Every bonus
is the amount the MFI is prepared to pay as a
system must be carefully designed and adapted to
5 bonus. It is possible to convert the bonus into any
the local situation. Do not e v e r copy someone
currency. In this illustration, summarized in Figure
elses system: rather, design your own! For a
1, the bonus factor is denominated in US$.
system to be successful, it:
The overall variables are weighted (w1 through w7)
Needs to incorporate the basic goals embedded
according to the importance of the respective
in the lending policies of the organization;
performance indicator to the MFI and can be
Must be fair. Loan officers should feel that defined for each loan officer individually, depending
better performance is adequately rewarded and on what the institution expects the loan officer to
that on average the goals set by the system are achieve during a certain period (usually one month).
achievable. This requires continual efforts by
managers to communicate fairness as an over- Each component of the formula is explained below.
all objective of the system, so that the inevitable
adjustments in the bonus formula are accepted Number of Loans Disbursed (L)
by loan officers as routine and not interpreted L is the number of loans disbursed to new and
as breaches of trust or as a lack of appreciation repeat clients by the following formula:
for their efforts;
Should be transparent so that loan officers can L = [(n / g) * w1 + (o / h) * w2] * w8
adjust their actions according to a few simple
parameters. Where:

No incentive system is perfect. All bonus systems n = The number of loans issued to new clients
must be regularly reviewed and adapted to the
changing business environment as well as to the g = The loan officers target for loans issued to
maturing of the lending organization. Finally, any new clients
system that helps to improve the performance and o = The number of loans issued to repeat
loyalty of staff deserves to be implemented. clients
h = The loan officers target for loans issued to
An Illustrative Incentive Scheme repeat clients
This section describes how an incentive scheme
might work. In this example, loan officers can earn w1, w2 = The weight given to the number of
a monthly bonus up to a maximum of US$400.
7 loans issued to new and repeat clients,
respectively. w1 plus w2 must equal 1. If more
importance is attributed to the number of loans
Among the many technical issues to be decided are: phasing in issued to new clients, w1 should be given a
bonuses, their total value, and frequency of bonus pay. For an weight greater than 0.5
overview of some of these considerations see Christen, Robert
P. (1997). Banking Services for the Poor: Managing for Financial
Success. Washington DC: ACCION, pp. 182-189. 7
In theory, a loan officer could earn a bonus higher than US$400
Transparency can be a problem when implementing bonus by overshooting the targets. Nevertheless, these are set so that
systems in downscaling environments in which department it is hard to surpass them, and readjusted as average
heads and branch managers would prefer to provide bonuses performance improves.
based on their own subjective assessments of loan officers 8
In the following paragraphs, the term arrears denotes
performance. portfolio-at-risk starting from the first day of irregular payment.



Figure 1: An Illustrative Incentive System

Vari Comments Value Factor Description Value
g (L) Target number of disbursed 10 w1 Weight factor for L 0.7 <1
loans to new customers number (new)
n (L) Actual number of disbursed 6 w2 Weight factor for L 0.3 <1
loans to new customers number (rep.)
h (L) Target number of disbursed 10 w3 Weight factor for P- 0.3 <1
loans to repeat customers volume
o (L) Actual number of disbursed 4 w4 Weight factor for P- 0.7 <1
loans to repeat customers number
b (P) Target number of 120 w5 Weight factor for A #la 0.5 <1
outstanding loans
d (P) Loan officers actual number of 80 w6 Weight factor for A $la 0.5 <1
outstanding loans
a (P) Target outstanding portfolio 600,000 w7 Weight factor arrears 5
c (P) Loan officers actual 450,000 w8 Bonus level factor L ($) 100
outstanding portfolio (US$)
#la (A) Actual number of loans in 3 w9 Bonus level factor P ($) 100
$la (A) Actual volume of loan officers 25,000 w10 Bonus level factor A ($) 200
loans in arrears (US$)

w8 = The bonus level factor for L standing, respectively. w3 plus w4 must equal
1. If more importance is attributed to the num-
In this sample calculation, the total monthly bonus
ber of loans than their size, then w4 should be
is US$400, which is divided up as follows: w8 = 100,
given a weight greater than 0.5
w9 = 100 and w10 = 200. However, if for a certain
period greater importance is attached to, say, new w9 = The bonus level factor for P
loan output rather than to low arrears, then w8
should represent a larger portion of the bonus than This formula assesses the extent to which the loan
w9 or w10. officer has achieved the established targets for
portfolio outstanding. In the sample calculation, the
In this example, the loan officer issued 6 loans to loan officer had an outstanding portfolio of
new clients, while the target was 10, and issued 4 US$450,000, or 75 percent of the US$600,000
loans to repeat clients, while the target was 10. As target. In this example, more significance was
a result, the bonus amount for L is US$54. given to the number of loans issued than their
L = [(n / g) * w1 + (o / h) * w2] * w8 value, since w4 was set at 0.7. It was probably felt
that the loan officer needed to increase the number
L = [(6/10) * 0.7 + (4/10) * 0.3] * $100 = $54 of loans (for instance to increase outreach or
diversification), and hence greater weight was
Portfolio Outstanding (P)
attached to this target. The target was 120 loans
P stands for portfolio and measures the extent to outstanding, whereas the loan officer achieved 80,
which a loan officer has met targets for the volume or 67 percent of the target.
and number of loans outstanding.
In our example the bonus for component P is
P = [(c / a) * w3 + (d / b) * w4] * w9
calculated as follows:
The individual variables are:
P = [(c / a) * w3 + (d / b) * w4] * w9
c = Loan officers total outstanding portfolio P = [($450,000/$600,000)*0.3 + (80/120) * 0.7] *
a = Loan officers target for outstanding portfolio $100 = $69.17
d = The actual number of outstanding loans Arrears (A)
b = The loan officers target for the number of A or arrears is determined by the following formula:
outstanding loans A = (w7 [(#la / d) * w5 + ($la / c) * w6]* 100)
w3, w4 = The weights represent the importance (w7 * w10)
given to the volume and number of loans out-



This formula calculates the degree (by volume and The formula outlined above is only one variant of
number) to which a loan officers portfolio is delin- the multitude of bonus systems employed by MFIs.
quent, and how much the bonus is reduced as a Attentive readers will have realized that the
consequence. The components of this formula are: example and its target values do not originate from
a high-productivity setting, such as urban Latin
w7 = The weight factor for arrears. This can be
America or Indonesia. Indeed, this fictitious case is
any number greater than or equal to 1. The
typical for Southeastern Europe and the Middle
lower the weight factor, the greater the negative
East, which are characterized by low productivity,
effect on the loan officers potential bonus. The
high loan officer salaries, and high average loan
use of this weight factor and the fact that the
sizes. But with a little imagination it is very easy to
arrears component is not deducted from the
adapt the formula to other contexts.
total bonus allows the institution to fine-tune the
impact of arrears targets by changing the fac-
tors every month. Thus, a loan officer may get Evaluation
a substantial bonus for bringing down the The example above has a couple of shortcomings
arrears rate. and some important strengths. Beginning with the
#la = The total number of loans in arrears in the advantages, the model contains many of the basic
loan officers portfolio variables that make up the target functions of
microlending organizations. Secondly, the formula
d = Total number of outstanding loans in the is flexible in that the parameters can be adjusted to
loan officers portfolio (same variable used in reflect different environments as well as different
component P) organizational values (e.g. the outreach objective
$la = The total balance of outstanding loans in can be strengthened by assigning a higher weight
arrears factor to the number of loans disbursed and out-
standing as opposed to the volumes). Thirdly, the
c = Loan officers total outstanding portfolio system is not overly complex and can be under-
(same variable used in component P) stood both by a keenly analytical loan officer and
reader of this Bulletin. The computation of
w5, w6 = The weight given to the number and
individual bonuses is simple enough and does not
volume of loans in arrears, respectively. w5
require more than a spreadsheet. Fourthly, the
plus w6 must equal 1. If more importance is
bonus formula is linear rather than staged.
attributed to the number of loans in arrears, w5
should be given a weight greater than 0.5. Staged bonus systems often produce unwanted
w10 = The bonus level factor for the arrears
portion of the formula. In our example the One of the models strengths is also a weakness:
arrears bonus level accounts for half of the total Microlenders have to act in a complex environment,
bonus, i.e. US$200 out of US$400. The loan and this simple formula may not reflect this com-
officer had 3 arrears cases representing a total plexity of tasks. It is possible to incorporate a
of US$25,000 at the end of the month. higher degree of complexity in the formula by add-
ing more variables, but this comes at the cost of
The bonus for part A is calculated as follows:
making the system less transparent. Loan officers
A = (w7 - (#la / d * w5 + $la / c * w6 * 100)) / w7 * w10 will find it harder to keep track of the trade-offs and
goal conflicts contained in the formula and to adjust
A = (5 ((3 / 80 * 0.5) + ($25,000 / $450,000 * 0.5) 10
their actions accordingly.
* 100)) / 5 * 200 = $88.14
Looking at this result and remembering the large The balancing of trade-offs is particularly relevant in
portion of the maximum total bonus (50 percent) the treatment of delinquency. The age of arrears
that the loan officer could have earned on arrears, it has a strong bearing on the chances of recovery,
appears that the loan officer failed to make which suggests that shorter-term arrears should be
significant progress on this objective during the past
month. 9
Loan officers will typically adjust their performance in these
circumstances so that they remain close to a particular stage or
Totals limit, e.g. a cap on the permitted arrears level. Linear systems,
Now that all three components of the formula have in contrast, provide a reward or penalty for any change in the
output or quality variables.
been calculated, combine them according to the 10
formula: Bonus = L + P + A. Thus, the resulting Remember that this concern was one of the reasons for
introducing an incentive system in the first place. An effective
bonus is: bonus system will induce loan officers to act in the interests of
the organization without additional supervision. If the system
$54 + $69.17 + $88.14 = $211.31 becomes too complex, this cannot be achieved.



subject to a higher penalty. However, it is also development are important components of loan
counterproductive to penalize short-term arrears officers job satisfaction and performance.
(say, from 1 to 7 days) too heavily since it would
make loan officers overly risk-averse and have a Nevertheless, loan officers are normally rational in
negative impact on productivity. This train of the economic sense, and few would deny that
thought could be factored into the model by financial incentives do provide an important stim-
assigning different weights to different age ulus. It is important to inform potential loan officer
categories. Furthermore, if delinquency is a serious candidates during the selection phase if a
concern for an institution with a large portfolio, the performance-based incentive system is in place or
formula could be improved by changing the purely is to be introduced. This will help to screen candi-
additive calculation contained in the example above dates by ensuring that they are willing to align their
into a multiplicative link between outstanding compensation expectations with the MFIs goals,
portfolio and arrears level, thereby making it much and to be compensated on the basis of their
more sensitive to portfolio quality. contribution to those goals; it will also help to sort
out risk-averse individuals. Despite the general
At a more general level, some readers may take limitations of monetary incentive systems, they
exception to this articles focus on financial have proven their value in practice.
incentives. Indeed, there are many other and
potentially more powerful factors that influence an Martin Holtmann is a Managing Director of IPC. He is
based in Moscow, working with several commercial
individuals job performance. Opportunities to re-
banks in the EBRD Russia Small Business Fund project.
ceive further training, opportunities for advance- The author would like to thank Andreas Francke, Bryan
ment, social status, the sense of a common Nielsen, and Ralf Niepel, all from IPC, for many useful
mission, and last but not least, the feeling of inputs and suggestions.
contributing to local or national economic and social