To remain competitive, microfinance institutions ( MFIs ) must listen to their clients, innovate, and find creative ways to lower the cost of service provision. As the rhetoric goes, the needs of the client come first. To serve clients better, MFIs have innovated through the use of new technologies such as: mobile money, agent banking networks, and driving savings mobilisation through savings group linkages to deposit-taking MFIs. In and of itself, tailoring one’s business to the needs of its clients is a sound business practice. Too often, the conversation stops here. Client feedback is solicited, new products are developed, the business grows. Client feedback is solicited, new products are developed, the business grows – and so the story goes.
This story, the current narrative of the microfinance industry, is incomplete and broken. MFIs are implicitly told that balance sheet growth must be realised to reach financial sustainability, and this may be true in many respects. However, what is largely missing is the narrative of risk management – a key component of the fundamental decision-making framework of any financial institution. Risk management plays an important role, not only in the health of financial institutions and their shareholders’ investment, but most importantly on the overall well-being of clients. Balance sheets have grown in size and complexity on the back of less than adequate personnel skill-sets, static risk management approaches, and frameworks in risk management, which do not adequately reflect the double-bottom line nature of microfinance. The microfinance industry is now playing catch-up and feeling the impact.
Over-indebtedness as a risk has received much attention in recent years. Yet this is only the tip of the iceberg. In Africa alone, the effects of these trends have been evidenced through an alarming number of MFI collapses. In August 2014, the Reserve Bank of South Africa bailed out African Bank Investments Limited ( ABIL ), due to issues that arguably point back to poor and imbalanced credit risk management. In Ghana, a country with no deposit guarantee scheme, the microfinance sector has experienced a risk management crisis that resulted in the collapse of over 50 MFIs. The collapse of many of these institutions was caused by failing to implement the basic tenets of liquidity risk management and solid financial intermediation by funding long-term assets with short-term liabilities. The subsequent result was severe liquidity crises, institutional collapse, loss of customer deposits and a reputational loss in sector confidence. One might stand back and wonder how we have arrive at this point in the development of this sector. The answer is complex and multifaceted.
Misaligned incentive mechanisms for proper implementation of risk management.
The incentives for conducting risk management in microfinance need to be viewed from the value they bring to an institution’s double bottom line – both social and financial. Currently, many institutions are wrongly incentivised by the licensing requirements for becoming a deposit-taking MFI or through investor requirements rather than from a deep understanding of the underlying value and importance risk management plays within a financial institution. As a result: Underperforming risk functions, robust policy manuals developed but not well understood or functionally used by staff and resounding cynicism towards risk management are resulting trends.
Lack in understanding of the proper role and value of risk management.
The risk management function is one of the most misunderstood functions within a MFI, often being confused with the roles of internal audits and compliance rather than playing its primary role of supporting the business units in maintaining policies and procedures, which ensure that all risks are identified, measured and managed throughout the institution. The damage and confusion caused by the improper creation and implementation of this function often outweigh the intended benefits. Without a proper understanding of the role and value of risk management, a MFI’s willingness to invest its own resources to build out this important function is negatively affected.
Lack of appropriate and generally accepted risk management standards in microfinance.
Feedback from recent microfinance risk management capacity-building programmes and industry stakeholders highlighted the need for comprehensive risk management industry standards for MFIs at different levels of their development. Given the variety of institutional types and their associated complexity, the industry is overdue for a scalable set of risk management standards. These standards would provide a MFI with forward-looking visibility on their risk management needs vis-à-vis the strategic growth included in their business plan. These standards would allow a MFI to proactively consider the risk management implications of meeting client demand, while simultaneously managing risk in the business planning and execution process.
In 2013, the Luxembourg-based NGO Appui au Développement Autonome ( ADA ) and seven other Founding Members, including Calmeadow, The Center for Financial Inclusion at Accion ( CFI ), Mennonite Economic Development Associates ( MEDA ), MFX Solutions, Microfinanza Srl., Oikocredit, and Triple Jump created the Risk management Initiative in Microfinance ( RIM ). RIM is a collaboration of organisations with a vested interest in raising the standards of risk management in the microfinance industry. RIM provides a platform for risk management standards development, information sharing, and industry cooperation.
RIM has successfully undertaken the development of the Risk Management Graduation Model (1), a pathways-based, best practice standard for risk management in the microfinance sector. The Risk Management Graduation Model has been designed to bridge the gap between the current state of risk management systems, tools, practices and required capabilities and that of the more sophisticated approaches proposed by the Basel Committee on Banking Supervision ( BCBS ). Through a diagnostic process, MFIs can assess their current risk management systems, structures and capabilities against RIM’s Risk Management Graduation Model and determine their adherence to best practice risk management standards applicable to their institutional tier level. Through a six-step institutional risk management improvement process, MFIs will be able to 1) Identify their institutional tier level and the appropriate standards within, 2) Assess their level of adherence to the Risk Management Graduation Model standards, 3) Strategise their Risk Management Graduation Path – a strategic improvement pathway, 4) Plan the necessary financial and human resources required to achieve the improvement goals, 5) Execute the plan within a project management framework and 6) Evaluate their plan’s level of success.
The goal of being a client-centric industry is a noble one. This goal must inevitably continue if we are ever to meet our aspirations of being a genuine double bottom line industry. However, as the industry shifts towards increasingly more financial intermediation, use of new technology and sophistication of balance sheets, the entire industry must take seriously a balanced approach that considers the risk implications of these and future developments. This is only possible if the microfinance sector itself agrees on the need to address the underlying incentive structures that exist, improve upon the current understanding and appreciation of risk management and its approaches and support the refinement and adoption of global microfinance risk management standards. To this end, the interests of the microfinance industry’s ultimate stakeholders – the clients themselves – can be protected.
( 1 ) The Risk Management Graduation Model framework will be available in mid-November 2014 and its associated Diagnostic Tool in 2015. Please visit RIM’s website to learn more : www.riminitiative.org
The original document is located here.
Kevin Fryatt is the Director of US-based RIM, which was founded in 2013 by ADA, Calmeadow, the Center for Financial Inclusion at Accion, MEDA, Microfinanza Srl, MFX Solutions, Oikocredit and Triple Jump.