managing risk.pdf

Managing Risk and Creating Value with Microfinance11Steps in Risk ManagementTable 1.3 describes the steps in risk management. The first step is to identify the institution’s unique riskprofile by analyzing the institution’s goals, needs, costs, and profitability. This step identifies the institution’ssocial and financial goals. It also assesses whether the operation is profitable and whether costs are adequatelycovered. In the second step, the MFI defines those unexpected events, or risks, that are most likely to occurand most important to manage. This process can be based on recent trends and experiences of other MFIs,as well as on potential political and economic changes. Management should focus on the top five internaland external risks. Using this analysis, in the third step, the MFI sets exposure limits for each line ofbusiness, for example, the percentage of total loans to a particular sector or a region or the percentage ofloans delinquent beyond 30 days. In the fourth step, once a limit has been passed, the institution implementsits risk analysis and control activities. Finally, the MFI adjusts the risk management system periodically—revising its risk profile and operational systems, as the political and business environments change over time.Table 1.3 Steps in Risk ManagementStepIdenfy risk profile, in delivery of financial services.Define most important risks (reviewed annually bymanagement).Set limits.Implement analysis and control system of regular checksand balances.Manage and monitor risks.Source: Adapted by authors from Mommartz (2006).AconsIdenfy• Goals, needs, costs, and profitability• Internal risks• External risksSelect• Top 5 internal risks• Top 5 external risksSet• Acceptable delays• Acceptable costs• Acceptable level of losses• Acceptable risks at the branch level• Risk levels measured in other waysImplement and monitor processes, reviews, and internalaudits—when limits are passed.Look for risk paerns, and address them strategically andoperaonally.For each risk category—internal or external—the successful MFI assesses the possible effects on its loanportfolio and policies. The portfolio includes all the outstanding loans, whether they are timely or overdue. Theloans may be of different size and character (individual or group) and to different productive sectors. Accordingto its mission and strategy, the MFI may have made preferential loans to women or productive sectors. Inaddition, its interest rates may or may not be competitive. Finally, the MFI’s holdings in other currencies willsubject the portfolio to changes in the exchange rate. The portfolio assessment will identify risks and helpmanagement to establish a balanced mix of loans. The following criteria will assist in developing the assessment:• Sectors to be served• Training level of the staff• Geographic coverage and depth• Level of tolerance for delayed payments