managing risk.pdf

Managing Risk and Creating Value with Microfinance19Effective management is critical for a microfinance institution (MFI) to achieve long-term financial successand its social mission. MFIs must manage change and make difficult decisions with clarity and consistencyof vision and mission. To be able to offer new products and services, successful MFIs must navigate changinglaws and regulations, increasing competition, entrance of new types of competitors (for example, banks), andchanges in technology, among other challenges. At the same time, they must deal with risk and vigilantly guardagainst fraud and loss of assets.This chapter describes governance concepts as they apply to the microfinance sector. It begins with a briefdiscussion of MFI owners and their effect on MFI governance. It then addresses the board and the board’spivotal role in sound MFI governance, outlining general best practices in MFI board operation. Finally, itincludes a governance self-evaluation tool (see annex) and a short reference list of relevant resources. 1The role of governance may be defined broadly as the system of people and processes through which anorganization maintains its focus and ensures institutional success. It includes the checks and balances neededto “manage managers.” Ultimately, good governance seeks• To uphold the organization’s goals and mission• To guide the organization’s major strategic direction• To maintain an organization’s health over time and to mitigate risks• To ensure accountability throughout the organization 2Despite the availability of resources that detail sound corporate and nonprofit governance, a 2008 survey foundquality of governance to be the second-greatest risk facing MFIs during times of rapid change. The surveyrevealed that many in the sector have strong doubts that many MFIs have the ability to adapt to new demandsand still retain their social objectives. 3Ownership, Legal Form, and Their Impact on Governance 4Governance of any institution is closely related to its ownership. The ownership structure has a significant effecton board structure, its effectiveness, and the risks it faces. Owners provide or control the institution’s funds orcapital and are interested in the institutional mission and results. Therefore, they want enough influence toensure adequate accountability through institutional governance.Different types of owners have particular sets of concerns, all of which tend to be closely linked to whatthe owner is hoping to gain from the investment. Because most MFI investors have financial andnonfinancial goals and priorities, they frequently use a “double bottom line” system, which balancesfinancial goals with a social mission, or a “triple bottom line” system, which adds environmentalconcerns: thus, they can evaluate the MFI’s success. Some owners are more sensitive to loss of financial orphysical assets; others, to loss of reputation, developmental goals, or institutional mission.1. This chapter is based on the April 2007 dialogue with presentations by Todd Farrington (ACCIÓN International), Tillman Bruett(Alternative Credit Technologies LLC), and Juan Manuel Díaz Parrondo (Instituto Dominicano de Desarrollo Integral). TillmanBruett was primarily responsible for this chapter, using the presentations, additional interviews, and research. He also developed thegood governance instrument presented at the end of the chapter.2. Council of Microfinance Equity Funds (2005), http://cmef.com/governancefinal.pdf.3. Centre for the Study of Financial Innovation (2008), http://cmef.com/CMEF5-BananaSkins.pdf.4. This discussion of ownership structure draws heavily from Otero (2001).