Financial Risk: Non Deposit-Taking MFIs
Financial Risk Types & Definitions
Financial risk is the risk of inefficiencies related to the management 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. Three subcategories have been identified within financial risk: liquidity risk, market risk (interest rate risk and foreign exchange risk, and equity price risk) and investment portfolio risk.
• Liquidity Risk – The risk of inefficiencies caused by the inability to meet current cash obligations in a timely and cost-efficient manner, usually due to the existence of mismatches in the maturity structure of assets and liabilities.
• Market Risk – Market risk refers to the risk of inefficiencies caused by changes in the value of an MFI’s assets and liabilities in response to changes in market rates.
• Interest Rate Risk – Interest rate risk refers to the risk of inefficiencies caused by an unfavorable change in interest rates, usually due to the existence of mismatches in the re-pricing structure of assets and liabilities.
• Foreign Exchange Risk – Foreign exchange risk refers to the risk of inefficiencies caused by an unfavorable change in exchange rates, usually due to the existence of mismatches in the currency structure of assets and liabilities.
• Equity Price Risk – Equity price risk refers to the risk of inefficiencies caused by an unfavorable change in the value of the group an MFI is part of.
• Investment Portfolio Risk – Investment portfolio risk refers to the risk of inefficiencies caused by the MFI’s investment portfolio (considering that for larger MFIs, a significant percentage of their assets are placed in financial or non-financial investments). This classification also includes the participation of MFIs in other companies.
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Liquidity Risk
Policies
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Commitment to manage liquidity risk. | Formal set of policies and procedures to manage liquidity risk. | Formal set of policies and procedures to manage liquidity risk. |
Limits
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Concentration limits with respect to lenders | ||
| Liquidity limits | Liquidity limits | |
| • Liquid assets with respect to total assets | • Liquid assets with respect to total assets | |
| Limits on coverage of time bands under contractual and dynamic scenarios. |
Risk Management Tools
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 | ||
| Pre-approved credit lines | Pre-approved emergency local and international credit lines | |
| Liquidity contingency plan |
Risk Monitoring Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Liquidity risk matrix | Up-to-date liquidity risk matrix | |
| Daily 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 |
| Monthly report of concentration in lenders | Weekly report of concentration in lenders | |
| Monthly report of main liquidity indicators | Weekly report of main liquidity indicators | Weekly report of main liquidity indicators |
| • Liquid assets with respect to total assets | • Liquid assets with respect to total assets | • Liquid assets with respect to total assets |
Interest Rate Risk
Policies
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Commitment to manage interest rate risk. | Commitment to manage interest rate risk. | Formal set of policies and procedures to manage interest rate risk. |
Limits
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Interest rate volatility limits | ||
| Interest rate exposure limits | Interest rate exposure limits | |
| • Sensibility gap | • Sensibility gap | |
| • Financial margin sensitivity | • Financial margin sensitivity | |
| • Equity sensitivity | • Equity sensitivity |
Risk Management Tools
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. |
| • Fixed vs variable interest rate | • Fixed vs variable interest rate | |
| • Maturity | • Maturity | |
| Interest rate contingency plan | ||
| Financial instruments to manage interest rate risk: | ||
| • Futures | ||
| • Forwards | ||
| • Swaps | ||
| • Options |
Risk Monitoring Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Interest rate risk matrix | Up-to-date interest rate risk matrix | |
| Quarterly interest rate volatility report | Monthly interest rate volatility report | |
| Quarterly interest rate exposure report | Monthly interest rate exposure report | |
| • Sensibility gap | • Sensibility gap | |
| • Financial margin sensitivity | • Financial margin sensitivity | |
| • Equity sensitivity | • Equity sensitivity |
Foreign Exchange Risk
Policies
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, including: | Formal set of policies and procedures to manage foreign exchange risk, including: |
| • Foreign currency-denominated credit products to reduce exposure | • Foreign currency-denominated credit products to reduce exposure |
Limits
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Currency volatility limits | ||
| Foreign exchange exposure limits: | Foreign exchange exposure limits: | |
| • Open positions with respect to equity | • Open positions with respect to equity | |
| • Financial margin sensitivity | • Financial margin sensitivity | |
| • Equity sensitivity | • Equity sensitivity |
Risk Management Tools
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 |
| • Local vs foreign currency | • Local vs foreign currency | |
| Foreign exchange contingency plan | ||
| Financial instruments to manage foreign exchange risk | ||
| • Futures | ||
| • Forwards | ||
| • Swaps | ||
| • Options |
Risk Monitoring Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Foreign exchange risk matrix | Up-to-date foreign exchange risk matrix | |
| Quarterly currency volatility report | Monthly currency volatility report | |
| Quarterly foreign exchange exposure report | Monthly foreign exchange exposure report | |
| • Open positions with respect to equity | • Open positions with respect to equity | |
| • Financial margin sensitivity | • Financial margin sensitivity | |
| • Equity sensitivity | • Equity sensitivity |
Equity Price Risk
Policies
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Commitment to manage equity price risk. | Formal set of policies and procedures to manage equity price risk. | Formal set of policies and procedures to manage equity price risk. |
Limits
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| No specific guidelines | No specific guidelines | No specific guidelines |
Risk Management Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| No specific guidelines | No specific guidelines | No specific guidelines |
Risk Monitoring Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Equity price risk matrix | Up-to-date equity price risk matrix |
Investment Portfolio Risk
Policies
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: | Formal set of policies and procedures to manage investment portfolio risk, including: |
| • Selection criteria for investments and institutions | • Selection criteria for investments and institutions | |
| • Identification of responsibilities (for example committees, treasurer, risk committee, risk unit) | • Identification of responsibilities (for example committees, treasurer, risk committee, risk unit) |
Limits
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Investment concentration and exposure limits | Investment concentration and exposure limits | |
| • By type of investment or financial instrument | ||
| • By institution | • By institution | |
| • By maturity | • By maturity | |
| • By currency |
Risk Management Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| 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 |
Risk Monitoring Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
| Investment portfolio risk matrix | Up-to-date investment portfolio risk matrix | |
| Monthly investment portfolio report | Monthly investment portfolio report | Weekly investment portfolio report |
| • Main characteristics of investments | • Main characteristics of investments | • Main characteristics of investments |
| • Main indicators of financial investments (for example value at risk, valuation, duration) | ||
| • Investment portfolio sensitivity analysis | ||
| Annual analysis of credit, inflation, interest and currency risks that may affect the investments’ value | Quarterly analysis of credit, inflation, interest and currency risks that may affect the investments’ value | Monthly analysis of credit, inflation, interest and currency risks that may affect the investments’ value |
Evaluate
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