Before Diving into Digital: A Guide for Microfinance Institutions

> Posted by Lynn Exton, Managing Partner, Exton & Partners Risk, Governance & Analytics LLP

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With the benefits of digital financial services (DFS) for enhancing financial inclusion now widely accepted, many microfinance institutions (MFIs) have or are planning to add new digital products to their delivery channels. But just because the benefits of DFS are relatively straightforward doesn’t mean the calculus behind whether or not institutions should take the digital plunge is. Institutions encounter practical challenges when adopting DFS, like big up-front investments in resources, the need for buy-in from staff and management, and the necessity for clients to change their behavior and adopt new technology. As with any new product, DFS also can introduce a wide range of risks to the MFI.

The Digital Financial Services Working Group recently released its newest publication, entitled, “The Digital Financial Services Risk Assessment for Microfinance Institutions – A Pocket Guide.” The guide was developed to assist MFIs in understanding the risks and corresponding mitigation strategies associated with DFS as well as to support institutions in choosing among the diverse business models available for providing these services. The DFS Working Group is a virtual community of practitioners and organizations developing knowledge management products promoting inclusive finance.

Before launching a new digital service, modeling and feasibility analysis is needed to determine whether the investment will likely be justified. The guide describes the spectrum of DFS MFIs can consider, though it does not attempt to fully analyze all of the options available as the fusion of DFS and microfinance is subject to constant innovation.

Considerations for DFS selection include the time and expense to be contributed by the provider and the electronic banking services already available in the market. For institutions considering incorporating an existing service, key questions concern the handling of the transaction data generated. How are reports accessed? Are they integrated into the institution’s existing MIS or into new soft/middleware? How does institution staff interface with the data?

With a sound risk assessment and robust risk mitigation strategies, regardless of which services model is selected, MFIs can successfully provide DFS that will ensure protection of assets, security of transactions, prevention of fraud, protection of client privacy, data security, compliance with laws and regulations, etc. The Pocket Guide helps identify and assess risks associated with providing DFS to clients prior to offering these products as well as on an ongoing basis.

Before conducting any risk assessment, institutions first need to understand the range of potential risks. The guide offers a categories framework for grouping DFS risks, with definitions and examples for each risk type. The categories of the framework are strategic, operational, liquidity, legal/regulatory, country, reputational, credit, and market. To name a few examples, the country category includes election period disruptions resulting from civil unrest, credit includes the risk of non-payment by clients, and market includes changes in foreign exchange rates negatively impacting international remittances. The risk assessment process might span institution departments including operations, credit, lending, risk management, internal audit, and others.

Because strategies to mitigate risks will vary according to each institution and its context, the guide does not prescribe specific risk mitigation strategies, but does provide some examples, issues, and lessons learned from the field. For instance, to combat some of the risks associated with operations like breakdowns in services technology, the guide advocates for thorough testing procedures. For example, an MFI’s employee payroll is a small system that can serve as a test case for a digital channel prior to its launch. The institution then has a mechanism to ensure that the system is operating without hiccups before opening up to the broader customer community, while also presenting institution employees the opportunity to closely familiarize themselves with the service. To determine mitigation strategies and actions, the guide also helps institutions gauge both the likelihood and potential negative impacts of risks. The Pocket Guide also has links to additional resources such as case studies, briefs, standards, and risk assessment tools.

Copies of the guide may be downloaded here.

Have you read?

The Risk Management Initiative in Microfinance (RIM): Mapping the Road to Risk Management

Heating Up… Risk Management as a New “Hot Topic” on the Microfinance Gateway

Emerging Themes in Responsible Digital Finance

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