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【Abstract】The micro-finance industry has been growing rapidly in the recent past. The rapid growth seems to continue, given the existence of massive unserved and underserved market. With the growth of the industry, the risk profile of MFIs is also changing. The MFIs are operating in an increasingly challenging economic environment, facing various financial, political and macroeconomic pressures. However, systematic risk management in MFIs is still not as widespread as it should be. Many MFIs seem to continue to seek growth without much attention to inherent risks. Increasingly, many MFIs appear to neglect even the basic credit risk management which can help them achieve high growth rates.
【Key words】Risk Management;Micro-finance Institutions
0.Introduction
Micro-finance focuses on providing credit and other financial services to people who run small, low-income, and often informal businesses. Many of these individuals are considered “not-bankable” by traditional commercial banks as they may lack credit history and therefore cannot meet minimum qualifications to gain access to credit from mainstream commercial banks. Micro-finance institutions (MFIs) address their target customers’ lack of credit history by using a detailed process to evaluate borrowers that focuses on both the client’s capacity and willingness to pay. While this method enables MFIs to successfully evaluate their potential clients, it is time consuming and not easily scalable or efficient. With risk management tools, MFIs can support the credit evaluation process and improve their portfolio quality. This article gives an overview of micro-finance risks and risk management framework which can be implemented by the MFIs.
1.MFIs Risks
Risk in the context of MFIs is the possibility of an adverse event occurring and its potential for negative implications on the future income of an MFI or deviation from the original social mission of an MFI. Looking at the mission statements of different MFIs globally, their main objective can be summarized as: providing financial relief for a significant proportion of the poverty-ridden population in the regions in which they operates; and maintaining financial self-sufficiency in order to provide sustained and efficient services to the clients. This means MFIs have both social mission and financial return objective. Striking a balance between the two competing objectives in essence exposes MFIs to a spectrum of risks.
The sources of these risks include increased competition in the market, addition of new credit products with longer-term structures, shift to individual lending, increased scale of operations, and geographical expansion and efforts to deepen their reach. To better explain these risks, they are categorized into three namely; financial risks, operational risks and strategic risks.
1.1 Financial Risks
Financial risks of MFIs are broad. They include;
Credit risk is the risk to earnings or capital due to borrowers’ late and nonpayment of loan obligations as well as risk of default by other financial institutions which have payment obligations to MFIs e.g. banks and service agencies. Credit risk includes both transaction risk and portfolio risk. Transaction risk refers to the risk in individual loans and portfolio risk refers to the risk inherent in the composition of the overall loan portfolio.
Liquidity Risk is the risk that an MFI cannot meet its obligations on time. This may be due to a number of factors. First, the average term structure of loans has increased in most MFIs because of increases in loan sizes, introduction of new loan products with longer maturities, and other related factors. Second, the demand for loans continues to grow at high rates. Third, short-term liabilities seem to have increased in importance in the liability structure. Thus, some MFIs are funding medium- to long-term loans with relatively short-term liabilities.
Market Risk these are risks associated with market dynamics. They include; interest rate risk, foreign exchange risk, and investment portfolio risk.
Interest Rate Risk is the risk of financial loss from changes in market interest rates. Foreign Exchange Risk is the potential for loss of earnings or capital resulting from fluctuations in currency values. MFIs most often experience this risk when they borrow or mobilize savings in foreign currency and lend in local currency. Investment Portfolio Risk refers to longer-term investment decisions rather than short-term liquidity or cash management decisions.
1.2 Operational Risks
MFIs are also subject to greater operational risk because of a number of factors. First, MFIs have become regulated financial institutions and therefore, subject to regulatory and compliance risk. Regulatory and Legal Compliance Risk is the risk of loss resulting from noncompliance with the country’s regulations and laws. Second, most MFIs have expanded their geographical coverage and their operational areas include those more prone to calamities, security problems, and other such risks. Some types of operational risks generally increase with distance from the head office, and control difficulties are more pronounced at branches located in remote areas. Third, the scale of cash operations of most MFIs has increased and many MFI staff members have easy access to the cash resources this exposes MFIs to fraud risks. Fraud Risk is the risk of loss of earnings or capital as a result of intentional deception by an employee or client. Fourth, many MFIs have increased their reliance on new information and communication technology. MFIs face operational risk whenever this technology malfunctions or breaks down. In addition, technological investments expose MFIs to technology risk which occurs when these investments do not produce the anticipated cost savings in economies of scale or scope, or do not result in anticipated increases in revenue.
1.3 Strategic risks
Issues relating to strategic positioning of MFIs also bring with it associated number of risks. These include; First, Governance Risk which is the risk of having an inadequate structure or body to make effective decisions. Second, Mission drift risk has also increased with the maturity of the industry. MFIs are under tremendous pressure to meet the changes in the markets and ownership, and the greater internal and external pressure to achieve reasonably high level of returns on equity while at the same time meeting its social goals. Third, the Competition Risks are natural outcome of the growing level of competition in the market as the industry matures over time. Although some early entrants have consolidated their position in the market and continue as market leaders, they have lost their near-monopoly position to new players. Fourth, MFIs also face much greater political risks than before. Such risks result from political instability, policy criticism, interest rates adjustments, pressure against tax exemptions among others. Last but not least is the reputation risk. Reputation is critically important for MFIs of all types. MFIs with a strong positive reputation can attract better staff, access large amount of funds, more clients, maintain customer loyalty and can easily expand their geographical coverage.
2.Framework for MFIs Risk Management Systems
Microfinance institutions face many risks that threaten their financial viability and long-term sustainability. Some of the most serious risks come from the external environment in which the MFI operates, including the risk of natural disaster, economic crisis or war. While the MFI cannot control these risks directly, there can prepare themselves and minimize their potential for negative impact through systematic risk management.
Risk management is the process of managing the probability or the severity of the adverse event to an acceptable range or within limits set by the MFI. It entails systematically identifying, measuring, limiting, and monitoring risks faced by an institution. A risk management system is a method of systematically identifying, assessing, and managing the various risks explained above. A risk management framework is a guide for MFI managers to design an integrated and comprehensive risk management system that helps them focus on the most important risks in an effective and efficient way.
2.1 Characteristics of a good risk management framework for MFIs
(1)Risk management framework should be well integrated into MFI operations. It should provide a set of systematic processes for identifying, measuring, and monitoring many different types of risk to help management keep an eye on the effectiveness of the MFIs.
(2)Uses a continuous feedback loop between measurement and monitoring, internal controls and reporting, and involves active oversight by senior managers and directors, allowing more rapid response to changes in internal and external risk environments.
(3)Considers scenarios where risks interact and can aggravate one another in adverse situations.
(4)Elevates responsibility for risk management and preparedness to senior management and the board and create down-up and up-down links within the MFIs.
(5)Encourages cost-effective decision making and more efficient use of available resources.
(6)Creates an internal culture of self-supervision that can identify and manage risks long before they are visible to outside stakeholders or regulators.
2.2 Developing Risk Management System Framework
Risk management is an interactive and continual process of ensuring that senior management is in-tune with the actual events in the field offices, and that the MFI responds promptly to any changes in its internal or external business environment. Successful MFIs incorporate risk management into their organizational design, lending methodologies, savings services, and operational procedures. The evaluation of risk management systems is a dynamic and a continuous process which includes; the identification of risks to be controlled, the development and implementation of strategies and policies to control risk, and the evaluation of their effectiveness. If results indicate those risks are not adequately controlled, then policies and strategies are redesigned, re-implemented, re-tested, and reevaluated until the desired results are achieved. Developing a systematic risk management framework involves the following steps:
(1)Gathering market knowledge: Review the target market, the features of available microfinance products and services, the local regulatory environment and competing microfinance providers.
(2)Train the management personnel: Equip microfinance staff with the basic tools and strategies for managing risk.
(3)Assess and define MFIs management information system (MIS) and existing database storage capabilities. Have all relevant information in place so as to adequately advance the MFIs knowledge capacity.
(4)Develop risk manual: Consolidate and document, or map out policies, practices and procedures related to the credit and account maintenance processes.
(5)Build risk management tools: Develop and implement tools to support decision making within the entire credit cycle (acquisition, maintenance, renewal and recoveries). These tools will assist in forecasting risk-related losses to enable the implementation of adequate mitigation tools in accordance with established guidelines.
(6)Formulate a risk-driven collection & recovery strategy: Evaluate collection capacity planning, collection strategies, implement collection risk matrix, collection performance tracking, and usage of risk evaluation tools to optimize recovery efforts.
(7)Develop scoring system: Develop tools for new customer evaluation (credit scorecard), maintenance strategies for existing clients (renewal scorecard) and risk-oriented recovery strategies (collection scorecard), including the development of score performance and population stability reports.
The steps in the risk management process are not static; they are part of an interactive and dynamic flow of information from the field to head office to senior management and back to the field.
3.Conclusion
The goal of good risk management is to reduce uncertainty and qualify potential financial losses as reasonable. Implementing risk management, however, is both art and science. The science is quantifying risks and probabilities so that an MFI can make informed decisions about the costs and benefits of risk management options. The art is to create an organizational culture of identifying risks without discouraging prudent risk-taking. Prudent risk-taking involves understanding the risk the MFI is assuming and recognizing that the upside reward potential carries the risk of loss. Losses should never come as surprises to management. The management at all time should be aware of the risks the MFI assumes and should understand the extent of the exposure and its potential implications.
【References】
［１］Bruett, Till.Four Risks That Must Be Managed by Microfinance Institutions.Microfinance Experience,Series 2 November.2004.
［２］Churchill,Craig,and Cheryl Frankiewicz.Making Microfinance Work:Managing for Improved Performance.Geneva:International Labour Office (ILO).2006.
［３］Deborah Drake and Elisabeth Rhyne．The Commercialization of Microfinance. Bloomfield: Kumarian Press.2006．
［４］Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ).A Risk Manageme
nt Framework for Microfinance Institutions. Frankfurt:GTZ.2000.
［５］Lee, Patricia.Corposol and Finansol: Institutional Crisis and Survival.2002.
［６］Powers, Jennifer.Shifting Technical Assistance Needs for Commercial MFIs: A Focus on Risk Management Tools. New York: Banyan Global.2005.
［７］Rhyne,Elisabeth and Maria Otero.Microfinance Through the Next Decade: Visioning the Who, What, Where, When and How. Boston: ACCION International.2006.
［８］Skees, Jerry R.Risk Management Challenges in Rural Financial Markets: Blending Risk Management Innovations with Rural Finance. Lead theme paper for paving the Way Forward for Rural Finance: An International Conference on Best Practices, held in Washington, DC, 2－4 June.2003.
【Key words】Risk Management;Micro-finance Institutions
0.Introduction
Micro-finance focuses on providing credit and other financial services to people who run small, low-income, and often informal businesses. Many of these individuals are considered “not-bankable” by traditional commercial banks as they may lack credit history and therefore cannot meet minimum qualifications to gain access to credit from mainstream commercial banks. Micro-finance institutions (MFIs) address their target customers’ lack of credit history by using a detailed process to evaluate borrowers that focuses on both the client’s capacity and willingness to pay. While this method enables MFIs to successfully evaluate their potential clients, it is time consuming and not easily scalable or efficient. With risk management tools, MFIs can support the credit evaluation process and improve their portfolio quality. This article gives an overview of micro-finance risks and risk management framework which can be implemented by the MFIs.
1.MFIs Risks
Risk in the context of MFIs is the possibility of an adverse event occurring and its potential for negative implications on the future income of an MFI or deviation from the original social mission of an MFI. Looking at the mission statements of different MFIs globally, their main objective can be summarized as: providing financial relief for a significant proportion of the poverty-ridden population in the regions in which they operates; and maintaining financial self-sufficiency in order to provide sustained and efficient services to the clients. This means MFIs have both social mission and financial return objective. Striking a balance between the two competing objectives in essence exposes MFIs to a spectrum of risks.
The sources of these risks include increased competition in the market, addition of new credit products with longer-term structures, shift to individual lending, increased scale of operations, and geographical expansion and efforts to deepen their reach. To better explain these risks, they are categorized into three namely; financial risks, operational risks and strategic risks.
1.1 Financial Risks
Financial risks of MFIs are broad. They include;
Credit risk is the risk to earnings or capital due to borrowers’ late and nonpayment of loan obligations as well as risk of default by other financial institutions which have payment obligations to MFIs e.g. banks and service agencies. Credit risk includes both transaction risk and portfolio risk. Transaction risk refers to the risk in individual loans and portfolio risk refers to the risk inherent in the composition of the overall loan portfolio.
Liquidity Risk is the risk that an MFI cannot meet its obligations on time. This may be due to a number of factors. First, the average term structure of loans has increased in most MFIs because of increases in loan sizes, introduction of new loan products with longer maturities, and other related factors. Second, the demand for loans continues to grow at high rates. Third, short-term liabilities seem to have increased in importance in the liability structure. Thus, some MFIs are funding medium- to long-term loans with relatively short-term liabilities.
Market Risk these are risks associated with market dynamics. They include; interest rate risk, foreign exchange risk, and investment portfolio risk.
Interest Rate Risk is the risk of financial loss from changes in market interest rates. Foreign Exchange Risk is the potential for loss of earnings or capital resulting from fluctuations in currency values. MFIs most often experience this risk when they borrow or mobilize savings in foreign currency and lend in local currency. Investment Portfolio Risk refers to longer-term investment decisions rather than short-term liquidity or cash management decisions.
1.2 Operational Risks
MFIs are also subject to greater operational risk because of a number of factors. First, MFIs have become regulated financial institutions and therefore, subject to regulatory and compliance risk. Regulatory and Legal Compliance Risk is the risk of loss resulting from noncompliance with the country’s regulations and laws. Second, most MFIs have expanded their geographical coverage and their operational areas include those more prone to calamities, security problems, and other such risks. Some types of operational risks generally increase with distance from the head office, and control difficulties are more pronounced at branches located in remote areas. Third, the scale of cash operations of most MFIs has increased and many MFI staff members have easy access to the cash resources this exposes MFIs to fraud risks. Fraud Risk is the risk of loss of earnings or capital as a result of intentional deception by an employee or client. Fourth, many MFIs have increased their reliance on new information and communication technology. MFIs face operational risk whenever this technology malfunctions or breaks down. In addition, technological investments expose MFIs to technology risk which occurs when these investments do not produce the anticipated cost savings in economies of scale or scope, or do not result in anticipated increases in revenue.
1.3 Strategic risks
Issues relating to strategic positioning of MFIs also bring with it associated number of risks. These include; First, Governance Risk which is the risk of having an inadequate structure or body to make effective decisions. Second, Mission drift risk has also increased with the maturity of the industry. MFIs are under tremendous pressure to meet the changes in the markets and ownership, and the greater internal and external pressure to achieve reasonably high level of returns on equity while at the same time meeting its social goals. Third, the Competition Risks are natural outcome of the growing level of competition in the market as the industry matures over time. Although some early entrants have consolidated their position in the market and continue as market leaders, they have lost their near-monopoly position to new players. Fourth, MFIs also face much greater political risks than before. Such risks result from political instability, policy criticism, interest rates adjustments, pressure against tax exemptions among others. Last but not least is the reputation risk. Reputation is critically important for MFIs of all types. MFIs with a strong positive reputation can attract better staff, access large amount of funds, more clients, maintain customer loyalty and can easily expand their geographical coverage.
2.Framework for MFIs Risk Management Systems
Microfinance institutions face many risks that threaten their financial viability and long-term sustainability. Some of the most serious risks come from the external environment in which the MFI operates, including the risk of natural disaster, economic crisis or war. While the MFI cannot control these risks directly, there can prepare themselves and minimize their potential for negative impact through systematic risk management.
Risk management is the process of managing the probability or the severity of the adverse event to an acceptable range or within limits set by the MFI. It entails systematically identifying, measuring, limiting, and monitoring risks faced by an institution. A risk management system is a method of systematically identifying, assessing, and managing the various risks explained above. A risk management framework is a guide for MFI managers to design an integrated and comprehensive risk management system that helps them focus on the most important risks in an effective and efficient way.
2.1 Characteristics of a good risk management framework for MFIs
(1)Risk management framework should be well integrated into MFI operations. It should provide a set of systematic processes for identifying, measuring, and monitoring many different types of risk to help management keep an eye on the effectiveness of the MFIs.
(2)Uses a continuous feedback loop between measurement and monitoring, internal controls and reporting, and involves active oversight by senior managers and directors, allowing more rapid response to changes in internal and external risk environments.
(3)Considers scenarios where risks interact and can aggravate one another in adverse situations.
(4)Elevates responsibility for risk management and preparedness to senior management and the board and create down-up and up-down links within the MFIs.
(5)Encourages cost-effective decision making and more efficient use of available resources.
(6)Creates an internal culture of self-supervision that can identify and manage risks long before they are visible to outside stakeholders or regulators.
2.2 Developing Risk Management System Framework
Risk management is an interactive and continual process of ensuring that senior management is in-tune with the actual events in the field offices, and that the MFI responds promptly to any changes in its internal or external business environment. Successful MFIs incorporate risk management into their organizational design, lending methodologies, savings services, and operational procedures. The evaluation of risk management systems is a dynamic and a continuous process which includes; the identification of risks to be controlled, the development and implementation of strategies and policies to control risk, and the evaluation of their effectiveness. If results indicate those risks are not adequately controlled, then policies and strategies are redesigned, re-implemented, re-tested, and reevaluated until the desired results are achieved. Developing a systematic risk management framework involves the following steps:
(1)Gathering market knowledge: Review the target market, the features of available microfinance products and services, the local regulatory environment and competing microfinance providers.
(2)Train the management personnel: Equip microfinance staff with the basic tools and strategies for managing risk.
(3)Assess and define MFIs management information system (MIS) and existing database storage capabilities. Have all relevant information in place so as to adequately advance the MFIs knowledge capacity.
(4)Develop risk manual: Consolidate and document, or map out policies, practices and procedures related to the credit and account maintenance processes.
(5)Build risk management tools: Develop and implement tools to support decision making within the entire credit cycle (acquisition, maintenance, renewal and recoveries). These tools will assist in forecasting risk-related losses to enable the implementation of adequate mitigation tools in accordance with established guidelines.
(6)Formulate a risk-driven collection & recovery strategy: Evaluate collection capacity planning, collection strategies, implement collection risk matrix, collection performance tracking, and usage of risk evaluation tools to optimize recovery efforts.
(7)Develop scoring system: Develop tools for new customer evaluation (credit scorecard), maintenance strategies for existing clients (renewal scorecard) and risk-oriented recovery strategies (collection scorecard), including the development of score performance and population stability reports.
The steps in the risk management process are not static; they are part of an interactive and dynamic flow of information from the field to head office to senior management and back to the field.
3.Conclusion
The goal of good risk management is to reduce uncertainty and qualify potential financial losses as reasonable. Implementing risk management, however, is both art and science. The science is quantifying risks and probabilities so that an MFI can make informed decisions about the costs and benefits of risk management options. The art is to create an organizational culture of identifying risks without discouraging prudent risk-taking. Prudent risk-taking involves understanding the risk the MFI is assuming and recognizing that the upside reward potential carries the risk of loss. Losses should never come as surprises to management. The management at all time should be aware of the risks the MFI assumes and should understand the extent of the exposure and its potential implications.
【References】
［１］Bruett, Till.Four Risks That Must Be Managed by Microfinance Institutions.Microfinance Experience,Series 2 November.2004.
［２］Churchill,Craig,and Cheryl Frankiewicz.Making Microfinance Work:Managing for Improved Performance.Geneva:International Labour Office (ILO).2006.
［３］Deborah Drake and Elisabeth Rhyne．The Commercialization of Microfinance. Bloomfield: Kumarian Press.2006．
［４］Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ).A Risk Manageme
nt Framework for Microfinance Institutions. Frankfurt:GTZ.2000.
［５］Lee, Patricia.Corposol and Finansol: Institutional Crisis and Survival.2002.
［６］Powers, Jennifer.Shifting Technical Assistance Needs for Commercial MFIs: A Focus on Risk Management Tools. New York: Banyan Global.2005.
［７］Rhyne,Elisabeth and Maria Otero.Microfinance Through the Next Decade: Visioning the Who, What, Where, When and How. Boston: ACCION International.2006.
［８］Skees, Jerry R.Risk Management Challenges in Rural Financial Markets: Blending Risk Management Innovations with Rural Finance. Lead theme paper for paving the Way Forward for Rural Finance: An International Conference on Best Practices, held in Washington, DC, 2－4 June.2003.