One of the biggest challenges faced by the industry is its failure in risk management. Earlier, microfinance institutions were operating at a small-scale, and credit evaluations were largely dependent on the reputation of the client, his/her estimates of their working capital and liquidity at hand. Hence, even though the lending was not backed by collateral, the repayment rate was high reaching 95%-98% as microfinance clients were always keen to maintain their reputation in the area that they are working/living in and credit officers were more familiar with their customer base.
The rise in competition and investment appetite led to the development of a much bigger scale of lending that spanned across much larger geographic areas and customer base. Hence, the personalized relationships between the microfinance institution and the customer diluted, and the subjective scoring used to assess debt capacity became insufficient. Responding to this, microfinance institutions took some measures to improve their credit risk management practices, including;

• The development of more rigorous credit policies
• The use of field verifications to support financial evaluation
• The use of credit history scoring to evaluate the risk of the loan
• The use of legal collateral documents such as bank cheques and promissory notes