> Posted by Kevin Fryatt, Director, Risk management Initiative in Microfinance (RIM)
“We do not engage in risk management because our CEO tells us that every department should be a profit center.” “Risk management seems useful, but how can we afford to pay for it?” Such industry sentiments have been the norm, I’ve found, in my work at the Risk management Initiative in Microfinance (RIM). These statements and many others like them reflect the reality that the value of risk management and its role within microfinance institutions (MFIs) have not yet fully been realized. As the microfinance industry matures and reaching scale through growth continues to drive the strategies of inclusive financial service providers, ways to create sustained value for their clients and shareholders will be increasingly sought after and explored. Finding ways to create sustained value, however, can often be challenging.
Risk management, if carried out effectively, is one important aspect in creating sustained value. Well-executed risk management derives organizational value by ensuring decision-making is carried out within an agreed-upon acceptable level of risk, ultimately providing greater certainty about returns against double-bottom line objectives through reducing volatility of net income and strengthening its ability to meet necessary social returns. For example, decisions on the acceptable amount of credit risk to accept may impact the amount of future financial losses an institution may suffer (financial return) while potentially impacting the type of clients it is able to serve (social return). If risk management has such a high potential to create sustained value, what then has been standing in the way of MFIs effectively implementing it to date?
Many factors explain the challenges in realizing the full value risk management can provide, and much of which point back to the lack of an appropriate risk management framework. Consider the following key framework characteristics:
- Scalability: MFIs have grown rapidly in recent years, and have, in many cases, outgrown their ability to proactively manage new and complex risks. An appropriate risk management framework must provide for scalability, providing senior management and board members the understanding of what appropriate risk management systems and decision-making structures look like at various levels of institutional development.
- Suitability: To be suitable, risk management for microfinance needs to reflect the subtle and not-so-subtle differences of the sector itself, providing for a comprehensive approach to the types of risks facing inclusive financial institutions. As a multiple bottom line industry, the way we define and evaluate risk must consider both financial and social performance losses, rather than financial losses alone. For example, transferring foreign currency risk to one’s clients may seemingly reduce financial risk to an institution in the short-term. However, what was once foreign exchange risk for the institution has now become foreign exchange risk for disadvantaged clients, ultimately putting at risk the institution’s social goals and objectives. Risk management frameworks from other industries, foremost the single bottom line focused commercial banking sector, cannot be transposed onto the microfinance sector. Doing so will render the approach incomplete.
- Availability: To date, approaches to risk management have been largely proprietary in nature, available to customers of expensive consulting firms or institutions linked to funders with technical assistance budgets. This has left the ability to implement formal risk management in the hands of those with the access to external financial support or larger, more developed institutions who can afford to pay out of internal resources. A publicly available risk management framework reduces the upfront barrier to implement risk management and allows for individuals and institutions to begin down the road of risk management capacity building with best practices at their fingertips.
At the beginning of 2013, the RIM set out to address these challenges. Its founding members embarked on the development of the Risk Management Graduation Model (RMGM), a pathways-based standard for risk management in the microfinance sector which provides risk management best practices applicable to various institutional tier levels. This framework has been tested in over 14 countries worldwide and within a variety of different legal and operational contexts. The RMGM provides an institution with a forward-looking view into best practice risk management systems and structures, allowing for proactive decision making, institution building, and resource allocation.
Risk management’s value proposition to MFIs can be realized through a common understanding of the types of risks inherent to the microfinance business model as well as through a common approach to the types of policies, limits, and tools necessary to adequately manage these risks throughout an institution’s growth process.
The RMGM framework for deposit-taking and non-deposit-taking MFIs, and the RMGM Assessment Tool, a tool which allows an MFI to assess its adherence to the RMGM framework, are publicly available for download on the RIM’s website.
RIM is a collaboration of organizations 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’s founding members include ADA, Calmeadow, Center for Financial Inclusion at Accion (CFI), MEDA, MFX Solutions, Microfinanza Srl, Oikocredit, and Triple Jump.
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