Financial Definitions & Core Concepts

This chapter defines the financial concepts, accounting principles, and microfinance mechanisms embedded in the BiiTrust core banking platform. Every term is grounded in actual industry standards and the system’s operational implementation.

1. Credit Risk & Portfolio Quality

Portfolio at Risk (PAR)

Portfolio at Risk (PAR) measures the proportion of the institution’s gross loan portfolio affected by delinquency. In banking and microfinance, once an installment is overdue by more than $x$ days, the entire outstanding principal balance of that loan is considered at risk, not merely the unpaid installment amount.

$$\text{PAR}_x = \frac{\sum \text{Outstanding Principal of Loans with Overdue Days} > x}{\text{Total Gross Loan Portfolio}} \times 100%$$

• PAR 30 (Default Standard): The global microfinance benchmark. Regulators (such as the Central Bank of Kenya - CBK) require non-deposit-taking and microfinance institutions to maintain PAR 30 strictly below 5.0%.
• PAR 60: Serious credit deterioration indicating failed field recovery attempts.
• PAR 90 (Non-Performing): Impaired credit facilities. Under prudential guidelines and IFRS 9, loans with $\text{DPD} \ge 90$ transition to Stage 3 (default/NPL) and require heavy loan loss provisioning.

Days Past Due (DPD)

The continuous calendar count of days elapsed since the oldest unpaid installment’s maturity date:

• $\text{DPD} = 0$: Current / Normal loan.
• $\text{DPD} = 1\dots 29$: Watchlist / Early Warning. Grace period typically spans 1 to 3 days.
• $\text{DPD} = 30\dots 59$: Substandard delinquency.
• $\text{DPD} = 60\dots 89$: Doubtful facility.
• $\text{DPD} \ge 90$: Non-Performing Asset (NPA) / Default. Eligible for legal recovery, collateral liquidation, and Credit Reference Bureau (CRB) listing.

Expected Credit Loss (ECL) & IFRS 9 Staging

Under International Financial Reporting Standard 9 (IFRS 9), loan loss provisions are computed proactively based on forward-looking credit deterioration rather than incurred losses alone:

1. Stage 1 (Performing):
   • $\text{DPD} < 30$ with no significant increase in credit risk since origination.
   • Provisioning: 12-Month Expected Credit Loss ($1.0% - 2.5%$ portfolio provision).
2. Stage 2 (Underperforming / Watch):
   • $30 \le \text{DPD} < 90$ or significant increase in credit risk (SICR).
   • Provisioning: Lifetime Expected Credit Loss ($10% - 25%$ specific provision).
3. Stage 3 (Credit-Impaired / Non-Performing):
   • $\text{DPD} \ge 90$ or objective evidence of borrower insolvency.
   • Provisioning: Full Lifetime ECL ($50% - 100%$ specific net impairment provision).

2. Payment Waterfall & Allocation Order

When a repayment arrives from an M-Pesa Paybill, bank deposit, or cash receipt, BiiTrust applies a strict financial waterfall allocation to settle overdue and current obligations. Funds are absorbed in institutional priority order:

$$\text{Incoming Payment} \longrightarrow \text{Penalties} \longrightarrow \text{Fees} \longrightarrow \text{Interest} \longrightarrow \text{Principal}$$

   ┌──────────────────────────────────────────────────────────┐
   │ 1. Late Penalties (Oldest accrued daily penalty charges) │
   └─────────────────────────────┬────────────────────────────┘
                                 ▼
   ┌──────────────────────────────────────────────────────────┐
   │ 2. Institutional Fees (Disbursement, rollover, ledger)   │
   └─────────────────────────────┬────────────────────────────┘
                                 ▼
   ┌──────────────────────────────────────────────────────────┐
   │ 3. Contractual Interest (Earliest due installment first) │
   └─────────────────────────────┬────────────────────────────┘
                                 ▼
   ┌──────────────────────────────────────────────────────────┐
   │ 4. Loan Principal (Reducing contractual debt balance)    │
   └──────────────────────────────────────────────────────────┘

• Waterfall Invariance: A borrower cannot pay toward principal while outstanding penalty fees or accrued interest remain open.
• Oldest First (FIFO): For multi-installment arrears, interest and principal are liquidated starting from the earliest overdue installment number before progressing to current installments.
• Overpayments: Payments exceeding total debt due are credited to unallocated suspense or held as advance savings on the client’s account.

3. Amortization & Interest Methodologies

Flat Interest Rate

Interest is computed as a fixed percentage on the initial disbursed principal across the entire tenor of the loan, regardless of ongoing principal repayments:

$$\text{Total Interest} = P \times r \times t$$ $$\text{Periodic Installment} = \frac{P + (P \times r \times t)}{n}$$

• Where:
  • $P$ = Disbursed Principal.
  • $r$ = Annual Contractual Interest Rate.
  • $t$ = Loan Duration in Years.
  • $n$ = Total Number of Repayment Installments.
• Microfinance Usage: Simplifies calculations for informal traders and group lending; however, the Effective Interest Rate (EIR) is roughly $1.7\times - 1.9\times$ higher than the stated nominal flat rate.

Declining / Reducing Balance Method

Interest is computed strictly on the unpaid outstanding principal balance at each repayment cycle:

$$\text{Interest}k = \text{Remaining Balance}{k-1} \times \frac{r}{m}$$

• Level Payment (Annuity / PMT Formula): $$\text{Periodic Installment (PMT)} = P \times \frac{\frac{r}{m} \left(1 + \frac{r}{m}\right)^n}{\left(1 + \frac{r}{m}\right)^n - 1}$$
• Where $m$ = Number of payment cycles per year (e.g., 12 for monthly, 52 for weekly).
• Characteristics: Interest is front-loaded; as principal amortizes, the interest portion of each installment declines, while the principal amortization portion increases. Paying early saves the borrower money.

Effective Interest Rate (EIR) & Annual Percentage Rate (APR)

• Nominal Rate: The headline interest rate stated in the contract without compounding or fee inclusions.
• Effective Interest Rate (EIR): The internal rate of return (IRR) of cash flows equating the disbursed funds with the present value of all repayments, fees, and charges.
• APR: The annualized total cost of borrowing disclosed to clients, factoring in appraisal fees, insurance levies, and disbursement deductions.

4. Tenor, Grace Periods & Moratoriums

• Tenor: The total duration from disbursement date to contractual maturity date (e.g., 6 months, 52 weeks, 36 months).
• Grace Period (Capital / Principal Grace): An agreed initial window (e.g., 14 days or 1 month) where the borrower does not pay principal installments, only interest. Common in agricultural lending where harvest cycles take time.
• Grace Period (Payment Leniency): Operational buffer (usually 1–3 business days after installment due date) before the system automatically applies daily penalty accruals.
• Moratorium: Complete freeze of all payment obligations (principal and interest) granted during formal debt restructuring or macroeconomic force majeure events.

5. Collateral, Valuation & Haircuts

Open Market Value (OMV)

The estimated fair economic value for which an asset could be exchanged between a willing buyer and a willing seller in an arm’s-length transaction following proper marketing.

Forced Sale Value (FSV)

The discounted cash price expected when an asset must be liquidated under distressed conditions within a constrained time frame (e.g., public auction within 30–60 days). Typically evaluated at $65% - 75%$ of OMV.

Valuation Haircut

A risk deduction applied to an asset’s market appraisal to absorb market volatility, depreciation, legal encumbrances, and auction costs:

$$\text{Pledged Value} = \text{OMV} \times (1 - \text{Haircut})$$

Standard BiiTrust Haircut Schedule:

• Motor Vehicles (Logbooks): $30% - 40%$ haircut on OMV.
• Titled Real Estate (Land / Buildings): $25% - 30%$ haircut on OMV.
• Household Goods & Equipment (Chattels): $50% - 60%$ haircut on OMV.
• Cash / Fixed Deposit Collateral: $0%$ haircut (100% lien).

Loan-to-Value (LTV)

The ratio comparing the loan amount to the discounted appraised collateral value:

$$\text{LTV} = \frac{\text{Disbursed Loan Principal}}{\text{Forced Sale Value (FSV)}} \times 100%$$

• Policy Ceiling: Institutional limit is strictly $\le 75%$ of FSV to guarantee full recovery in default.

6. Credit Bureau (CRB) Reporting

• Credit Reference Bureau (CRB): Regulated repositories (e.g., Metropol, CreditInfo, TransUnion) tracking credit history across licensed financial institutions.
• Positive Reporting: Monthly reporting of all performing loans, establishing borrower creditworthiness.
• Adverse Listing: Mandatory submission of loan accounts that remain in default ($\text{DPD} \ge 90$) following statutory pre-listing notice (28-day notice).
• Clearance Certificate: Official document issued to a borrower once all adverse default balances have been cleared and reported as closed.

7. Know Your Customer (KYC) & Anti-Money Laundering (AML)

• KYC (Know Your Customer): Mandatory statutory due diligence process verifying the true legal identity, physical address, and source of funds for all borrowers.
• Customer Due Diligence (CDD): Standard verification of government identity card, phone registration, and tax registration (KRA PIN).
• Enhanced Due Diligence (EDD): Deeper background audits, asset verification, and proof of income required for Politically Exposed Persons (PEPs), high-net-worth borrowers, or high-value business facilities.
• Sanction Screening: Automated checking against international terrorist, financial crime, and politically exposed registries.

8. General Ledger & Double-Entry Accounting

Chart of Accounts (COA)

The structured index of financial ledger accounts organized under standard banking classes:

• 10000 - Assets: Cash on Hand, Bank Accounts, M-Pesa Treasury, Gross Loan Portfolio, Accrued Interest Receivable.
• 20000 - Liabilities: Borrower Collateral Deposits, Accounts Payable, Credit Facility Borrowings.
• 30000 - Equity: Shareholder Capital, Retained Earnings, Statutory Reserves.
• 40000 - Revenue: Interest Income on Loans, Loan Processing Fees, Penalty Charges.
• 50000 - Expenses: Staff Payroll, Office Rent, Bank Fees, Loan Loss Provision Expense.

Double-Entry Invariance

Every financial movement in BiiTrust triggers a balanced journal entry where Total Debits equal Total Credits:

9. Mobile Money & Payment Rails

• C2B (Customer to Business): Inbound payment where a borrower uses their Safaricom M-Pesa menu (Paybill or Till) to transfer funds into BiiTrust’s treasury.
• B2C (Business to Customer): Outbound payment where BiiTrust dispatches approved loan proceeds directly to the borrower’s mobile phone number.
• STK Push (SIM Tool Kit Push): Interactive USSD pop-up sent directly to the borrower’s phone requesting PIN entry to authorize an instant repayment.
• Paybill vs Till:
  • Paybill (Business Number): Requires an Account Number field (used by BiiTrust to specify borrower client number or loan hex).
  • Till Number (Buy Goods): Direct merchant transfer without an account number.
• Reconciliation: Nightly verification matching M-Pesa statement transactions with internal payment ledger records to detect unallocated payments or duplicate receipts.