Financial Risk: Non 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.
Liquidity Risk
Policies
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 |
Limits
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 |
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 |
Limits on coverage of time bands under behavioral scenario | Limits on coverage of time bands under behavioral scenario |
Risk Management Tools
Risk Monitoring Tools
Interest Rate Risk
Policies
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 |
Limits
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 |
Risk Management Tools
Risk Monitoring Tools
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 risk exposure report, including: | Quarterly interest rate risk exposure report, 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 |
Foreign Exchange Risk
Policies
Limits
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 |
Risk Management Tools
Risk Monitoring Tools
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 |
Investment Portfolio Risk
Policies
Limits
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 |
Risk Management Tools
Risk Monitoring Tools
Capital Adequacy Risk
Policies
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
Formal policies on dividend distribution | Formal policies on dividend distribution | Formal policies on dividend distribution |
Limits
Risk Management Tools
Tier 3 Guidelines |
Tier 2 Guidelines |
Tier 1 Guidelines |
Not applicable | Not applicable | Not applicable |
Risk Monitoring Tools
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 |
Evaluate