Monitoring Portfolio Quality 

In order to protect the loan which are overdue and may not be recovered (also refereed as doubtful debts) a percentage of loans outstanding should be transferred to loan loss reserve. It is the recorded as a negative asset in the balance sheet as a reduction of the outstanding portfolio or can be shown as a liability. MFI usually show a loan loss provision as an expense in income and expenditure statement. The loan loss reserve can be determined by MFI based on past loan history if it is not regulated by the Government. 

A credit enhancement strategy that state and municipal governments frequently employ to give lenders some risk coverage. The reserve will cover a certain number of loan losses.

When the MFIs are sure that a loan is not going to be repaid, such loans are written off against the loan loss reserves made. In many cases MFIs continue to show non recoverable loans as part of the portfolio as they do not have any write-off policy. This is not a good practice as their portfolio loses value over a period of time. A written off policy also help the MFIs to present accurate financial statements, it is always advisable to write-off the loan which are not repaid over and above a period of one year. The MFI should continue its efforts to recover the loans even though they are written off from the books. If they are received at a later stage this amount can be shown as other income. 

In essence, writing off a loan means that it will no longer be considered an asset. A bank can lower the amount of non-performing assets (NPAs) on its records by writing down loans. The fact that the sum has been written off lowers the bank's tax obligation is an additional benefit.

Loan loss ratio relate to the ratio of amount written off in a period to average portfolio outstanding. It is an important indicator to measure portfolio quality. When compared with delinquency rate, the loan loss ratio helps to understand the quality of the portfolio. 

The ratio of all non-performing loans to loan provisions against potential losses is referred to as the ratio. This metric shows how well equipped financial institutions are to cover their problematic loans in the event of default.