Financial Risk: Deposit-Taking MFIs

Financial risk is the risk of financial losses and negative social performance related to the maturity, currency, re-pricing, and concentration structure of an MFI’s assets and liabilities. As MFIs face product differentiation among loan assets and more choices in funding sources, it becomes increasingly important to manage these risks effectively. There are four subcategories of financial risk: liquidity risk, market risk (including interest rate risk and foreign exchange risk), investment portfolio risk, and capital adequacy risk.

  • Liquidity Risk – Liquidity risk is the risk of financial losses and negative social performance related to the inability to meet current cash obligations in a timely and cost-efficient manner, to have adequate liquidity to fund planned growth and survive through crisis. Liquidity risk often arises because of mismatches in the maturity and concentration profiles, as well as the behavioral nature of an institution’s assets and liabilities.
  • Market Risk – Market risk is the risk of financial losses and negative social performance related to changes in the value of an MFI’s assets and liabilities. These changes as determined by fluctuations in interest and foreign exchange rates in the market. Market risk is subdivided into interest rate risk and foreign exchange risk.
    • Interest Rate Risk – Interest rate risk is the risk of financial losses and negative social performance related to unfavorable changes in market interest rates that are caused by mismatches in the re-pricing structure (re-pricing risk) or caused by basis risk—the imperfect correlation between market reference rates and internally managed rates on an MFI’s interest-rate-sensitive assets and liabilities.
    • Foreign Exchange Risk – Foreign exchange risk is the risk of financial losses and negative social performance related to unfavorable changes in exchange rates, usually due to mismatches in the currency structure of assets and liabilities.
  • Investment Portfolio Risk – Investment portfolio risk is the risk of financial losses and negative social performance related to an MFI’s investment portfolio. It covers the cases in which larger MFIs have a certain percentage of their assets in financial or non-financial investments. Investment portfolio risk also includes equity investments in MFIs or other companies, if applicable.
  • Capital Adequacy Risk – Capital adequacy risk is the risk of financial losses and negative social performance related to the capacity of an institution’s equity base to absorb risk.
  • Policies
  • Limits
  • Risk Management Tools
  • Risk Monitoring Tools
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Formal set of policies and procedures to manage liquidity risk
Formal set of policies and procedures to manage liquidity risk
Formal set of policies and procedures to manage liquidity risk
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Concentration limits with respect to lenders
Concentration limits with respect to lenders
Concentration limits with respect to lenders
Concentration limits with respect to depositors
Concentration limits with respect to depositors
Concentration limits with respect to depositors
Liquidity limits
Liquidity limits
Liquidity limits
• Net liquid assets with respect to total assets
• Net liquid assets with respect to total assets
• Net liquid assets with respect to total assets
• Net liquid assets with respect to deposits up to 90 days
• Net liquid assets with respect to deposits up to 90 days
• Net liquid assets with respect to deposits up to 90 days
• Net liquid assets with respect to concentration of deposits
• Net liquid assets with respect to concentration of deposits
• Net liquid assets with respect to concentration of deposits
• Net liquid assets with respect to volatility of sight deposits
Limits on coverage of time bands under behavioral and dynamic scenarios
Limits on coverage of time bands under behavioral and dynamic scenarios
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Coherent product and funding strategies to avoid maturity mismatches
Coherent product and funding strategies to avoid maturity mismatches
Coherent product and funding strategies to avoid maturity mismatches
Funding plan
Funding plan
Funding plan
Liquid investment accounts
Liquid investment accounts
Liquid investment accounts
Pre-approved credit lines
Pre-approved credit lines
Pre-approved emergency local and international credit lines
Liquidity contingency plan
Liquidity contingency plan
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Mapping of liquidity risks (at least every two years)
Mapping of liquidity risks (at least every two years)
Annual mapping of liquidity risks
Weekly monitoring of liquidity levels
Daily monitoring of liquidity levels
Daily monitoring of liquidity levels
Monthly projected cash flow report
Weekly projected cash flow report
Weekly projected cash flow report with backtesting
Monthly report of concentration in lenders
Monthly report of concentration in lenders
Weekly report of concentration in lenders
Monthly report of main liquidity indicators, including:
Monthly report of main liquidity indicators, including:
Monthly report of main liquidity indicators, including:
• Net liquid assets with respect to total assets
• Net liquid assets with respect to total assets
• Net liquid assets with respect to total assets
• Trend analysis
• Trend analysis
• Trend analysis
• Limits comparison
• Limits comparison
• Limits comparison
Monthly behavioral liquidity report
Monthly behavioral liquidity report with backtesting and stress-testing
  • Policies
  • Limits
  • Risk Management Tools
  • Risk Monitoring Tools
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Commitment to manage interest rate risk
Formal set of policies and procedures to manage interest rate risk
Formal set of policies and procedures to manage interest rate risk
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Interest rate spread limits
Interest rate risk exposure limits
Interest rate risk exposure limits
• Net interest income sensitivity
• Net interest income sensitivity (with basis risk adjustment)
• Sensitivity of economic value of equity
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Coherent product and funding strategies to avoid interest repricing mismatches
Coherent product and funding strategies to avoid interest repricing mismatches
Coherent product and funding strategies to avoid interest repricing mismatches
Interest rate contingency plan
Derivative instruments to manage interest rate risk
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Mapping of interest rate risks (at least every two years)
Mapping of interest rate risks (at least every two years)
Annual mapping of interest rate risks
Quarterly interest rate spread analysis, including:
Quarterly interest rate spread analysis, including:
Quarterly interest rate spread analysis, including:
• Limits comparison
• Limits comparison
• Limits comparison
• Repricing gap analysis
• Repricing gap analysis
• Net interest income sensitivity
• Net interest income sensitivity (with basis risk adjustment)
• Sensitivity of economic value of equity
Quarterly interest rate volatility report
Monthly interest rate volatility report
Quarterly interest rate stress-testing report
  • Policies
  • Limits
  • Risk Management Tools
  • Risk Monitoring Tools
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Commitment to manage foreign exchange risk
Formal set of policies and procedures to manage foreign exchange risk
Formal set of policies and procedures to manage foreign exchange risk
The MFI does not transfer foreign exchange risk to the client
The MFI does not transfer foreign exchange risk to the client
The MFI does not transfer foreign exchange risk to the client
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Foreign exchange risk exposure limits
Foreign exchange risk exposure limits
• Net open position
• Net open position
• Stressed FX income sensitivity
• Stressed FX income sensitivity
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Coherent product and funding strategies to avoid currency mismatches
Coherent product and funding strategies to avoid currency mismatches
Coherent product and funding strategies to avoid currency mismatches
Non-derivative instruments to manage foreign exchange risk
Non-derivative instruments to manage foreign exchange risk
Derivative instruments and non-derivative instruments to manage foreign exchange risk
Foreign exchange contingency plan
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Mapping of foreign exchange risks (at least every two years)
Mapping of foreign exchange risks (at least every two years)
Annual mapping of foreign exchange risks
Monthly currency volatility report
Weekly currency volatility report
Quarterly foreign exchange risk exposure report, including:
Quarterly foreign exchange risk exposure report, including:
• Net open position
• Net open position
• Stressed FX income sensitivity
• Stressed FX income sensitivity
• Compared to limits
• Compared to limits
Value at risk analysis
Quarterly foreign exchange stress-testing report
  • Policies
  • Limits
  • Risk Management Tools
  • Risk Monitoring Tools
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Commitment to manage investment portfolio risk.
Formal set of policies and procedures to manage investment portfolio risk, including selection criteria for investments and institutions, as well as identification of responsibilities (committees, treasurer, risk unit, etc.)
Formal set of policies and procedures to manage investment portfolio risk, including selection criteria for investments and institutions, as well as identification of responsibilities (committees, treasurer, risk unit, etc.)
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Investment concentration and exposure limits:
Investment concentration and exposure limits:
• By institution
• By institution
• By maturity
• By maturity
• By type of investment or financial instrument
• By currency
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Dedicated person or committee to determine permitted financial institutions, instruments, and concentrations
Committee to determine permitted financial institutions, instruments, and concentrations
Tool (scoring model) and committee to determine permitted financial institutions, instruments, and concentrations
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Mapping of investment portfolio risks (at least every two years)
Mapping of investment portfolio risks (at least every two years)
Annual mapping of investment portfolio risks
Monthly investment portfolio report, including main characteristics of investments
Monthly investment portfolio report, including main characteristics of investments
Weekly investment portfolio report, including main characteristics and indicators of investments, as well as investment portfolio sensitivity analysis
  • Policies
  • Limits
  • Risk Management Tools
  • Risk Monitoring Tools
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Formal policies on dividend distribution
Formal policies on dividend distribution
Formal policies on dividend distribution
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Minimum percentage of annual profits to be capitalized
Minimum percentage of annual profits to be capitalized
Minimum percentage of annual profits to be capitalized
Limit for debt-to-equity ratio or adjusted capital over risk-weighted assets
Limit for debt-to-equity ratio or adjusted capital over risk-weighted assets
Limit for adjusted capital over risk-weighted assets
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Not applicable
Not applicable
Not applicable
Tier 3 Guidelines Tier 2 Guidelines Tier 1 Guidelines
Monthly monitoring of capital adequacy levels and trends, including:
Monthly monitoring of capital adequacy levels and trends, including:
Monthly monitoring of capital adequacy levels and trends, including:
• Debt-to-equity ratio or adjusted capital over risk-weighted assets
• Debt-to-equity ratio or adjusted capital over risk-weighted assets
• Adjusted capital over risk-weighted assets
• Trend analysis
• Trend analysis
• Trend analysis
• Compared to limits and projections
• Compared to limits and projections
• Stress-testing