When listening to clients becomes a risk : the current state of the microfinance industry and a call for better microfinance risk management

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.

 

 

MicroCapital Monitor Special Report: A Risk Management “Graduation Model” for Microfinance

SPECIAL REPORT

This sneak preview of European Microfinance Week is sponsored by the European Microfinance Platform (e-MFP), a 130-member network located in Luxembourg.

A Risk Management “Graduation Model” for Microfinance 

MicroCapital: How does the state of risk management within microfinance fit in to the broader context of the industry?

Kevin Fryatt: In the last several years, we have seen a lot of focus on new technology and serving clients better through new product development, savings mobilization and agent networks, amongst other avenues. Similarly, institutions’ balance sheets are getting increasingly diverse in the types of funding they are sourcing. But within this, the conversation of risk management isn’t happening. There’s a sense of cynicism within the leadership of microfinance institutions (MFIs) toward risk management. It is often misunderstood and confused with the roles of internal audit or compliance. It is often very difficult to quantify the value of risk management. If we look at the incentives for good risk management, what we generally see are institutions engaging in more formal risk management, number one, because it’s a requirement of the regulator to get a deposit-taking license, as opposed to thinking, “We are going to be taking deposits, and there are new and challenging risks from a funding and reputational perspective that go along with raising deposits.” The other piece is from funders, who may tell an institution, “Okay, we would like to see ABC in place, and we are actually willing to give you some financial resources to make that happen.” In order to get the financing, an institution will then engage in the technical build-out of a risk management function, yet there might not be the political will within the institution to really engage in this in a sustainable and effective way. Having an institution pay entirely out of its own resources to improve this function is quite rare.

MC: What do you consider the key elements of risk management for an MFI?

KF: The fundamentals that we consider first and foremost are institutional culture, risk management governance, internal control structures and having a management information system (MIS) in place that can collect data in a way that helps an institution quantify these risks. We see a lot of underperforming MISs that aren’t producing timely data or data that are of high enough quality for analysis. Without that, conducting formal risk management is very difficult.

MC: How do these fundamentals relate to the Graduation Model that the Risk management Initiative in Microfinance (RIM) is developing?

KF: There are relatively sophisticated approaches that are being proposed, and then there is the reality of where MFIs currently are. The idea behind the Graduation Model is that we need to develop formalized and appropriate risk management standards for institutions in different levels of development. Within the Graduation Model, we are developing a diagnostic process that can identify what “tier” the MFI is in, and then its staff will be able to score the institution’s adherence to the standards for its tier. This will help MFIs have conversations about the future and what their risk management requirements should be as they grow. Within the strategic planning process, this will allow them to start proactively allocating resources and getting staff skill sets prepared or hiring new staff as they prepare for the future. In some instances, institutions that have fairly large balance sheets – and might be looked at as Tier-1 institutions from an asset standpoint – are living up to only Tier-3 standards from a risk management standpoint. Recently in Ghana, I have seen reports that anywhere from 50 to 60 microfinance institutions have collapsed since 2013. And some of that, fundamentally, has to do with risk management. In Uganda, the same thing is happening: I’ve had conversations with the association of microfinance institutions there, and risk management is one of its top concerns. After MFIs use the Graduation Model to make strategic decisions about where they want to build out capacity, they can engage whichever technical service provider they wish to support them. Or they can approach technical assistance facilities to assist with co-financing and sourcing consultants. A lot of the skills in the risk management space come from the West and bring a fairly expensive price tag. To address this, RIM endeavors to facilitate the training of a pool of local talent, so an institution in Kenya, for example, can engage with folks locally or regionally, which can ultimately reduce the cost to the institution.

MC: How can our readers participate in this process?

KF: The Graduation Model will be released to the public for free on our website in time for European Microfinance Week, which begins November 12. We are inviting organizations to become members of RIM, be part of our governance structure and join our working groups. One of those is our technical working group, which is primarily responsible for building out these standards. Also, we are actively looking for highly influential people in the industry who understand the core issues that face the industry as well as senior-level risk management experts who can help advise RIM both from a strategic standpoint as well as from a technical standpoint. We are currently piloting the Graduation Model in a number of MFIs around the world, and we are continually looking for additional MFIs to participate.


 

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.

Visit MicroCapital Monitor Special Report for the original document.

Banana Skins: The risks facing the microfinance industry

Wednesday, December 3, 2014 at 12 pm
Banque de Luxembourg | 14, Boulevard Royal | Luxembourg

Risks are the main cause of uncertainty in any organisation. Companies increasingly focus on identifying and managing potential issues because preparing the steps to manage perils can help any sector resolve them effectively.

Microfinance is not exempt from these problems. In the past, this sector has already experienced the effects of poor risk management in a variety of different forms, from saturation in India to local currency depreciation and unnecessary foreign exchange losses in Kenya. Since then, many financial experts have focused on the subject.

What are the main potential problems that keep the microfinance actors awake at night? Overindebtedness, financial capability, competition or liquidity? What are the main risks the industry is currently facing and what are those they may be facing in the future?

Answers to these questions can be found in the recent edition of Microfinance Banana Skins 2014: Facing Reality which aims to describe these potential risks, the “banana skins” that the inclusive finance industry has to face across the globe.This outstanding publication, published since 2008, has been written thanks to the contribution of more than 300 practitioners and close observers of the microfinance industry in 70 countries.

We are glad to welcome the microfinance experts Sam Mendelson and Daniel Rozas, two of the authors of Microfinance Banana Skins, who will give us the keys to understand the main risks the financial inclusion sector is facing during our 29th edition of the Midi de l’inclusion financière.

The conference will be held in English.

The Banana Skins survey was prepared by the Centre for the Study of Financial Innovation (CSFI), an independent London think tank, and funded by the Citi Foundation and the Center for Financial Inclusion at Accion.

Download the Banana Skins for free here.

Sign up now!

As the number of seats is limited, please register before Friday 28 November 2014, through our online registration or by phone on +352 45 68 68 1.

The car park of the Banque de Luxembourg is not accessible to the public, we recommend using public transportation.

This event is organized by ADA. More information on conferences held in Luxembourg regarding the issues at stake and changes in the financial inclusion sector visit Midi de l’inclusion financière.