The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

What will this year’s Microfinance Banana Skins Survey top message be? We are eagerly awaiting the responses to the recently launched 2014 Microfinance Banana Skins Survey from practitioners, investors, regulators, and other industry stakeholders around the world. These responses will provide insights into the greatest perceived risks facing the sector over the next few years and reveal the risks to be avoided on the path ahead.

The titles of the past four Microfinance Banana Skins surveys paint the picture of continuous sector evolution since the first publication in 2008. If previous titles are any indication, the new headline will set the tone and raise a debate around key risk issues.

Entitled “Risk in a Booming Industry“, the 2008 report highlighted concerns of microfinance institutions about “how to scale” in a healthy way. With changed economic realities, the external environment became the area of focus with “Confronting Crisis and Change” in 2009, and “Losing Its Fairy Dust” in 2011. The most recent survey in 2012, “Staying Relevant,” highlighted the changed setting for microfinance brought on by new entrants and new technologies. The titles and changing risk rankings reflect the increasing integration of microfinance into the broader financial ecosystem, and the challenges that microfinance clients and service providers encounter as the sector evolves.

Reflecting the shift in focus from microfinance to financial Inclusion, this year’s Microfinance Banana Skins survey has made a deliberate attempt to broaden participation from microfinance to a wider range of service providers, including new players in the evolving landscape of financial inclusion, and to rethink the risks relating to service providers, clients, and the market environment.

What will be the title of the 2014 Microfinance Banana Skins Survey? Perhaps this time the risk concerns will be more focused on the client?

If you have received the Microfinance Banana Skins questionnaire from CSFI, please take a very few minutes to complete it online TODAY if you have not done so already. The deadline for your input is Friday, the 28th of February.

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Banana Skins 2012: Improving MFI Governance

Is Microfinance Losing Its Fairy Dust?  ‘Banana Skins 2011′ Holds the Answers

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

The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

Before the advent of the People’s Bank of China’s county-level pilot program to create microcredit companies (MCCs) and village and township banks (VTBs), there was a large number of unbanked individuals and micro-entrepreneurs whom commercial banks were unwilling to serve. Hence when the pilot program to create MCCs, the product of a financial inclusion plan by the Chinese government, went into action in 2005 the number of MCCs boomed, and in the past few years they have mushroomed to an astounding number of 9,000 as of 2013. The Chinese financial sector has been plagued with corruption in the past few years – for example, the Wu Ying private lending network scandal and the Qilu commercial bank forgery in Shandong. To circumvent corruption and maintain control of the increasingly overpopulated sector, regulators enforce strict capital requirements and caps on interest rates. However, these requirements are stifling the operational sustainability of these MCCs. Joe Zhang, author of the book Inside China’s Shadow Banking: the New Sub-prime Crisis? writes, “The regulation is killing the dynamism of the sector. Everyone in the sector is working extra hard to make a modest return (after huge expenses and bad debts).”

Should 9,000 MCCs all be painted with the same regulatory brush?

Some industry leaders believe a rating system for microcredit companies is the answer. Liu Ping, Director General of the Senior Advisors of the People’s Bank of China, believes ratings can be a yardstick to measure the sustainability of microcredit companies and differentiate the good apples from the bad. MCC investors hope that high grades based on credible ratings could move the authorities to loosen restrictions on outlets, so that business costs could be better covered, individual company branches could grow, and the sector could eventually be made more sustainable. Conversely, low rating grades would expose institutions with questionable practices that require operational changes. In addition, a ratings system may change the popular perception that these institutions are “loan sharks”, leading to increased investment, institutional growth, and client outreach.

Rating systems – a staple of the traditional finance sector – play an important role in microfinance globally. Rating agencies select and weigh indicators for both companies issuing debt and the debt instruments, setting benchmarks for the industry and allowing for factors of comparison amongst companies. Rating reports create access to the risk analysis of debt and debt issuers, increasing market transparency and facilitating investors in sourcing investments, performing credit decisions, and supervising risk. For investees, monitoring of issuers of debt instruments encourages issuers to act in the interests of the investor community which leads to best management practices.

Currently, there are seven approved rating companies in China. Two of these companies are joint ventures with international credit rating agencies – Lianhe Credit with Fitch and Chengxin Credit with Moody’s. Chinese rating companies commonly perceive that getting an accurate picture of MCC operations is unfeasible due to the rather unreliable nature of financial reporting amongst Chinese MCCs, rendering traditional rating methods bogus. Currently, no single regulator has all the data needed to form a comprehensive picture of an MCC. Instead, they advocate a market based approach. If markets can ascertain reliable information, then ratings systems can be built around these indicators. Lianhe Credit applies this market-based approach by performing credit investigation instead of ratings. “The main utility for us is to help the provincial-level supervisors construct information systems that can give them a better grasp on the target MCC’s operations,” says Lianhe’s CIO, Shi XX. The Provincial Office of Financial Affairs in each province, which were abruptly tasked with the duty of regulating MCCs in May 2008, are dedicating energy and time to rating systems. Even if policy restrictions aren’t loosened, MCCs and financial affairs offices now have new management and supervision tools to supplement standard reporting and provide greater clarity to investors.

From the outset, there has been heated debate over the methodologies and goals of a microfinance rating system. Ed Wu, Managing Director of PlaNet Finance China suggests that the most common risk factors in determining sustainability are governance, strategy, risk management skills, IT systems, and funding. The importance of effective risk governance is also emphasized in Governing Banks: MFI Edition by CFI’s Running with Risk project. These risk factors should be taken into account when developing new rating schemas.

When overburdened with companies to regulate, Provincial Offices of Financial Affairs (POFA) may be inclined to use ratings to single out non-compliant MCCs or MCCs with poor risk management in order to revoke business licenses and closely supervise operations. The provinces with the greatest numbers of MCCs urgently need the ability to differentiate among them and are working quickly to establish a ratings infrastructure. Some areas, such as Tianjin, already require a yearly rating report and audit report to be submitted to the local POFA. Additionally, in Jiangsu, Inner Mongolia, and Yunan, POFAs either own state-owned enterprises that do ratings or have internal rating standards and schemes for regulatory purposes.

The concept of ratings for MCCs is taking off and may enable regulators to relax the regulatory noose strangling strong MCCs, whilst reining in MCCs with less than ideal operations. To learn more about this topic, please look out for the joint report by PlaNet Rating and PlaNet Finance coming out in the first quarter of 2014, written with the support of the Credit Suisse microfinance capacity building initiative.

Have you read?

Emerging Risks on China’s Path Toward Financial Inclusion

Designing Financial Services for China’s Marginalized

A Journey to Understanding Risk as a New Board Director in “Governing Banks MFI Edition”

The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

Making the case for more attention to risk management and governance in both the financial inclusion sector and corporate world can be an uphill battle, but McKinsey’s Global Survey findings provide some strong reinforcement. If we let the numbers speak for themselves, they tell an interesting story. Their survey of 772 corporate directors showed that although over 90 percent of respondents reported that their boards have become more effective over the past five years, risk management still surfaces as the biggest difficulty faced by boards.

The survey shows that board directors have improved their knowledge on various company issues since the last survey conducted in 2011. More specifically, about one-third say they have a complete understanding of their organization’s current strategy, as compared to about 20 percent in 2011. However, only 15 percent can say the same for the risks their company faces. In fact, the reality is that 30 percent of directors reported they have limited to no understanding of the risks facing their company.

You might ask why there is such a difference. The answer lies in the time directors spend on the two topics. Directors responded that they spend more time on strategy than any other area, 28 percent compared to only 12 percent for risk management. This clearly shows where their priorities and attention are focused. McKinsey mentions that companies and boards are becoming more complacent about risks as the 2008 financial crisis becomes a more distant memory — unfortunately fading memories do not translate to fading risks.

Along with understanding risks, another area where board directors said they wanted to improve is in the amount of time they spend on their role, with North American directors working a significantly less number of days on company matters than their European and Asian counterparts. The survey further shows that time spent on governance has been correlated with higher-impact boards, who say “they evaluate resource decisions, debate strategic alternatives, and assess management’s understanding of value creation much more often.”

Other positive findings from the survey include that board directors feel more confident overall in their board’s work and the amount of influence they hold. Seventy-three percent rated their board’s decisions and activities as having a high impact on the company’s financial success. One factor that directors often attributed to the board’s improved effectiveness was having more active or skilled independent directors.

Finally, we were excited to see in McKinsey’s takeaways the need for increased attention to risks, more time spent on governance, and learning from peers. They point out that “Directors at boards with less impact have much to learn from the actions taken by higher-impact boards, and not only when it comes to strategy.”

To learn about the Center for Financial Inclusion’s efforts around peer learning for governance, please read more about our recent Governance Leadership in a Competitive World seminar for MFI board members and CEOs.

Chart credit: McKinsey & Company

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

A Journey to Understanding Risk as a New Board Director in “Governing Banks: MFI Edition”

Staying the Course When Risks Rise: Advice for Board Members

The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

What good are industry best practices for risk management if many MFIs don’t have the tools and resources to follow them? Sure, you can state that it is an industry best practice to have a risk committee on your board. And it undoubtedly is important to identify that there is value in applying such a practice. But what use is that really if you don’t examine the underlying reasons why 40 percent of MFIs that responded to a MIX survey said they don’t. Or why 32 percent reported not having a risk manager, and 23 percent said they don’t have an internal auditor – and if they did have either, respondents indicated, “both functions tend to report to the CEO contrary to accepted best practice.”

To address this disconnect between where we are as an industry and where we want to be in terms of risk management best practices is why the Risk management Initiative in Microfinance (RIM) was recently launched. RIM is a collaborative effort of Appui au Développement Autonome (ADA), Calmeadow, the Center for Financial Inclusion at Accion (CFI), Mennonite Economic Development Associates (MEDA), MFX Solutions, Microfinanza, Oikocredit, and Triple Jump to raise awareness about the importance of risk management, and build MFIs’ capacity to more effectively understand and manage risk.

It has been shown time and again that there is no one-size-fits-all solution in the microfinance industry. What works in one region for one MFI could be a disaster in a different region or for another MFI. And risk management is no different. Putting out one set of risk standards would create a divide between those that meet them and those that don’t, and those that are a good fit for them and those that aren’t. Instead RIM is in the process of developing a “risk roadmap” to help MFIs assess where their risk management capabilities currently stand, and to then help them navigate to where they want to be in terms of risk management. This risk model will help MFIs continue to “graduate” to higher levels of risk management capabilities as they grow and mature as institutions. This roadmap will provide the microfinance industry with a flexible resource, appropriate to address the wide variety of risk management challenges MFIs face.

RIM’s work to raise awareness and help build capacity is taking the shape of several other forms as well, including:

• Adding risk as a new Microfinance Gateway  Hot Topic, which was launched about a month ago, thanks to the help of a talented team of Credit Suisse Virtual Volunteers and with input from ADA.
• Hosting a panel at the European Microfinance Week to present the risk graduation model.
• Developing a virtual “marketplace” where MFIs are matched with the risk technical experts that can answer their risk-related questions, or provide more in-depth risk-related technical assistance.

Through these efforts, with a personalized and individual approach, RIM aims to advance the risk management abilities of MFIs everywhere.

Have you read?

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

A Journey to Understanding Risk as a New Board Director in “Governing Banks: MFI Edition”

Staying the Course When Risks Rise: Advice for Board Members

The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

It’s heating up—maybe not in terms of the weather but certainly in terms of growth and competition for many microfinance institutions (MFIs). And as growth and competition rapidly increase in many countries, there are many potentially serious risks and impacts that MFIs need to take into account. As we have seen in the crises in Andhra Pradesh, Nicaragua, and Morocco – to name a few – microfinance is risky business, and it can be argued that many industry failings result from poor risk management and oversight. It might also be fair to say that risk management didn’t garner much attention before because times were good, but now, as more markets heat up, it is important that we learn from past mistakes, and focus the necessary resources to implement preventative risk management measures.

To provide MFIs with the risk management resources needed to help tackle this challenge, we are excited to announce that Risk Management was recently added as a “Hot Topic” on the Microfinance Gateway! The risk management resources now available through the Microfinance Gateway were compiled by a dedicated team of Credit Suisse Virtual Volunteers¹ in coordination with the newly established Risk management Initiative in Microfinance (RIM)², which was created to raise awareness as well as develop best practices and appropriate standards for risk management in microfinance globally.

On the Gateway’s new Risk Management Hot Topic, in addition to recommended readings and tools, you’ll find information on the main risks facing the microfinance industry, the major challenges for implementing risk management, and discussions on topics such as risk appetite, stress tests, and the role of the board. This Hot Topic is meant to be a helpful starting point for MFIs to access resources to support their efforts and initiatives around sound risk management.

Have you read?

A Journey to Understanding Risk as a New Board Director in “Governing Banks: MFI Edition”

Staying the Course When Risks Rise: Advice for Board Members

Ten Questions for Every Board Member

[2] Founding RIM Members include: Appui au Développement Autonome (ADA), Calmeadow, Center for Financial Inclusion at Accion (CFI), Mennonite Economic Development Associates (MEDA), MFX Solutions, Microfinanza Srl, Oikocredit, and Triple Jump.

The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

“What does he know that I don’t know?” This is exactly the question proponents of peer learning want to provoke. In academia, peer learning has received significant attention and new peer learning communities are sprouting up around the world. From the virtual Peer 2 Peer University, or P2PU, which was founded in 2009, to the Indian non-profit Avanti with its peer Learning Centers in India, to more informal community-driven websites like Skillshare where anyone can teach anyone else about a skill.

The Center for Financial Inclusion at Accion (CFI), the Boulder Institute of Microfinance, and Calmeadow Foundation are applying the power of peer learning in our upcoming “Governance Leadership in a Competitive World” seminar in Mexico City on October 3-4, 2013. The seminar asks MFI board members and CEOs to come together to address governance and risk challenges microfinance institutions are facing. The seminar will employ a highly interactive combination of case-based peer discussion, experienced industry speakers, and problem-solving.

Peer learning actually isn’t a new concept. It had its birth around 1916 with education thinker John Dewey’s Constructivist Theory which asserts that knowledge is created through experience, rather than through the usual teacher to student lecture and memorization. Paulo Freire, the Brazilian development guru, took it a step further with his 1968 book Pedagogy of the Oppressed, which critiques traditional teaching frameworks that treat students as empty vessels into which knowledge is deposited. Freire challenged society to ensure that all participants in the classroom, both teachers and students, work together to create knowledge equitably.

In the early ‘90s, researchers identified 10 different models of peer learning, such as student tutoring, a buddy system for counseling, peer-assessment, discussion seminars, and workplace mentoring. Peer learning has come to be defined as a two-way, reciprocal learning activity, with the involved parties mutually contributing to each other’s learning. Peers are people of equal status in a similar situation and with similar goals. Their experience and expertise can differ, which makes the interaction, discussion, and learning richer. In the case of the Governance Leadership seminar, the peers are the MFI board members and CEOs.

David Boud, Emeritus Professor of Adult Education at the University of Technology Sydney, says that, “Peer learning should be mutually beneficial and involve the sharing of knowledge, ideas and experience between the participants.”

Other recognized benefits of peer learning are that the participants develop skills in working collaboratively with others and in giving and receiving feedback. In addition, there is the emotional support component that learners provide for each other, which can be as powerful and important as the technical knowledge learned. The support component presents itself most strongly when discussing challenges and receiving validation, solidarity, and/or advice on how to address it. The Power of Peer Learning: Networks and Development Cooperation also recognizes the value of peer pressure for encouraging accountability, self-assessment, and transparency.

The Corporate Executive Board (CEB) uses a model built on learning from peer perspectives and networks, highlighting the profile of senior leaders which peers can compare themselves to and thereby recognize ways to improve.

The Governance Leadership seminar aims to incorporate all of these lessons into its pedagogy. It will feature facilitators who are industry leaders in microfinance with expertise in governance and risk. These facilitators will engage board members in an active dialogue about governance challenges and their roles as directors. It will address risk reduction and crisis management strategies necessary at the board level. These activities leverage participant experience and provide the opportunity to observe best practices, exchange ideas, and apply key takeaways to strategic operations. Case exercises will highlight the greatest risks MFI boards face, including weak management, excessive growth, and a highly competitive environment, and will be used to spar discussion about the appropriate board responses to those risks. The seminar will provide board members with opportunities to interact with others within their geographic context and facilitate greater understanding of the regional challenges that frame the risks MFIs confront today.

With insights on governance and risk management developed through discussions with their peers, board members will have improved capacity to oversee their microfinance institutions, and this will ultimately result in better services for their clients.

If you would like more information on the Governance Leadership in a Competitive World seminar, or would like to attend, please check out the brochure.

Have you read?

Staying the Course When Risks Rise: Advice for Board Members

Ten Risk Questions for Every MFI Board

How Can MFI Boards Be Explicit about Risk Strategy and Appetite

The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

Effective risk governance is critical for the growth and sustainability of an MFI, and board members play an important role in overseeing, monitoring, and controlling institutional risks. Governing Banks: MFI Edition, the latest publication of the Center for Financial Inclusion’s Running with Risk project, is a comprehensive risk and governance manual that follows a newly appointed director of an MFI bank on his journey to acquire the understanding and skills needed to meet the unique challenges of his role. Through the different characters the director meets, including the Chair of the Board, CEO, and Chair of the Risk Committee of the Board, the author Karla Brom holds a candid, educational, and easy-to-read conversation. She discusses a multitude of topics, including best practices in determining board composition, risk management roles and responsibilities, and risk appetite.

Governing Banks: MFI Edition builds on the work of the Governing Banks supplement created by IFC’s Global Corporate Governance Forum, and modifies the document to take into account the specifics of regulated microfinance institutions. For the MFI Edition, valuable input and oversight were provided by an advisory team comprised of Lauren Burnhill of One Planet Ventures, David Risser of NestorAdvisors, Mike Lubrano of Cartica Capital, Keith Waitt of Consultancy Matters, and Deborah Drake of the CFI. The publication is the third output of the Running with Risk project, which seeks to raise awareness about the importance of effective risk governance for institutional growth and sustainability. The first two publications were Microfinance – A Risky Business and Ten Risk Questions for Every MFI Board.

Governing Banks: MFI edition will be published in three parts, and Part 1 of this publication, focusing on risk governance, was released today and can be found on the CFI website, here.

Have you read?

Staying the Course When Risks Rise: Advice for Board Members

Ten Risk Questions for Every MFI Board

How Can MFI Boards Be Explicit about Risk Strategy and Appetite

The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

Being a board member of an MFI is challenging. As MFIs are evolving, board members face an ongoing stream of strategic questions, and more technical expertise and specific knowledge about financial products are becoming necessary. As an MFI grows, employees and stakeholders have increasingly high expectations for board members.

The challenge for the board member is to be a coach as well as to control the management, and to stay engaged despite the fact that the MFI is always changing.

Risk management is one changing area. Risk management is no longer just a small function hidden in the finance department. More risk types are becoming relevant including such “exotic” categories as reputational and legal risk. In addition, increased integration into countries’ financial systems also means a higher exposure to interest rate and liquidity risk, and increased awareness by the regulatory authorities.

How can board members play an active and useful role for the MFI that faces such challenges?

1. Stay Engaged or Increase Your Involvement in the MFI

The MFI might look different than when the board member joined, but this is not a reason to back off. More sophisticated MFIs require stronger involvement and personal commitment. The board member should spend more time with the MFI, participate in more meetings, pay visits to the institution, and test the products the MFI is offering. One suggestion is to organize social gatherings, including dinners, around the time of board meetings and invite selected employees to join. If well organized, such gatherings promote information exchange and a better understanding of the tasks and responsibilities on both sides.

2. Don’t Be Defensive

Some board members react with fear and uncertainty to change. This often leads to defensive behavior. In facing the external world, an MFI requires a board member who is approachable. Also be aware that there are high expectations from the stakeholders. A board member needs to be up-front in his or her communication.

3. Accept Personal Limitations and Use Them to Involve More Experts

The technical challenges and knowledge requirements for risk management are complex and occasionally are difficult to understand. Even if the board member has risk management expertise, the requirements over the last ten years have changed dramatically. As a consequence, it is acceptable to either ask for additional explanations or request that specific experts be added to the board or invited as coaches. A board member will not be blamed for admitting a lack of knowledge, but will be held responsible for not communicating.

4. Stick to the Strategy

Board members are responsible for the MFI’s strategy. However, in exercising oversight, they need to recognize that the execution of strategies often requires more time than hoped. While it is important to make sharp decisions if things go too badly askew, a board member should not turn to tactical adjustments as soon as the strategy is not implemented perfectly.

5. Maintain a Positive Relationship with Regulators

Regulators are powerful, and they prefer transparent and well-managed MFIs. A good reputation can be built by maintaining a positive and professional relationship with the regulators. If the communication flow is frequent and based on mutual respect, then difficult scenarios or small crises can be solved more easily.

6. Step Down to Free the Space for New Faces

If the challenges above become too much, it is the most honorable decision for a board member to step down and free the space for someone with the right expertise. Executing such a step in the regular course of business will preserve the reputation of the board member. Many companies have created advisory boards that reputable members of the community and experts are invited to join. Such advisory boards are not subject to regulations, therefore generally no liability can arise from membership. But the advisory board does allow experts to contribute to the strategic development of the MFI. A departing board member could join such an advisory board.

Board members should know that the challenges they are facing may sound unique but are actually shared among board members in many different industries and across all countries. Few board members only face problems with which they are already familiar. It is therefore useful to reach out to colleagues in similar situations. Social networks like LinkedIn might help in contacting other board members and sharing questions and concerns. Just as lifelong learning and an ongoing curiosity is expected from the staff of an MFI, it is equally relevant for board members.

This post comes from Investing in Inclusive Finance’s recently released publication Ten Risk Questions for Every MFI Board. In the publication, 10 industry risk experts each address one tough risk question, as Christian has done here. Topics such as over-indebtedness, fraud, “newer” risks, and lack of information are examined, offering insight on some of the most difficult risk issues that board members face. Christian’s section of the publication has been modified slightly for this blog post. The publication is available electronically on the CFI website, here.

Christian Ruehmer is a senior consultant in risk management for microfinance. He is the co-founder of Perfect Point Partners (PPP), a consulting company that focuses on efficiency and risk for MFIs and founder of Proyecto Horizonte, a village development project that supports over 800 children and families in Bolivia.

Have you read?

Emerging Risks on China’s Path Towards Financial Inclusion

Ten Risk Questions for Every MFI Board

How Can MFI Boards Be Explicit about Risk Strategy and Appetite

The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

You may have caught Philip Brown’s blog post last month on how MFI boards can be explicit about risk strategy and appetite. Philip’s post was one of 10 responses collected for the publication, in which industry experts each candidly responded to one tough risk question that every board member should be asking, and be able to answer. The publication, Ten Risk Questions for Every MFI Board, was officially released today.

Through the publication, we set out to cover topics such as over-indebtedness, risk management measures, fraud, “newer” risks, and lack of communication, offering insight on some of the most difficult risk issues that board members face. Ten Risk Questions for Every MFI Board provides concrete warning signs and strategies for effectively managing or avoiding specific risks. We hope this resource will empower board members to speak up when they are uncomfortable about a move the MFI is making, or when they think an early warning sign of a larger problem may be present.

The publication is part of the Center’s Running with Risk project, which seeks to raise awareness about and enable effective risk governance for the institutional growth and sustainability of MFIs. Running with Risk is creating a common framework and language around risk so both the MFI’s management and board of directors better understand the potential of their roles, and can more adequately anticipate and manage risks. In Ten Risk Questions for Every MFI Board, the various experts discuss the importance of boards in determining and assessing how much risk is acceptable for the MFI and taking responsibility in leading the institution to ensure that the proper policies, procedures, and people are in place.

Ten Risk Questions for Every MFI Board is available for download on the CFI website. Along with Philip Brown, the publication includes responses from risk experts Lynn Exton, Karla Brom, Alex Silva, Liliana Botero, Daniel Rozas, Petronella Chigara-Dhitima, Stephan Hartenstein, Andrés Calderon, and Christian Ruehmer.

Have you read?

How Can MFI Boards Be Explicit about Risk Strategy and Appetite

A Core Reference Tool Updated: CMEF’s Governance Guidelines

Banana Skins 2012: Overindebtedness Tops the Risk Charts

The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

It may not be explicitly articulated and may be just “what we do” but all MFIs have a risk strategy and risk appetite. Board members have a responsibility to become active shapers of their organizations’ risk strategies and appetites, so that they can guide their institutions into waters of appropriate depth.

Each board member brings different perspectives to the table, but collectively, the board needs to have a view on the key macro and micro entity and performance risks and their possible impact on the MFI. At a high level these risks can be broken down into strategic/business model risks (clients, products, and delivery channels), operational risks (i.e., how the MFI functions), financial risks (funding, liquidity, FX risk), and compliance risks (adherence to regulations, client code of conduct). However, setting and monitoring risk strategy and appetite is not a checklist exercise. There are some on-going broader risk guidance principles that boards might utilize as part of being explicit about risk strategy and appetite. 

Set Risk Culture/Tone at the Top:

Risk management is about managing MFI performance against expected performance. Boards represent shareholders and stakeholders who have an established view on the MFI’s expected performance and business and risk boundaries. This view is evidenced in plans, guidelines, minutes, and the focus of on-going board agendas. New investors, who signify change, can alter this consensus around expected future risk, profile, and performance. In any event the view of risk is dynamic. Market vagaries and operational performance will inevitably require on-going risk profile adjustments to strategic, operational, financial, and compliance risks, and lending models. This degree of risk tolerance, “how we operate,” will trickle-down throughout the entire institution from the board to the management to individual, daily staff decisions.

Create Risk Boundaries:

For overall and major business decisions, boards should discuss the potential range of expected outcomes, including the ideal, base, and downside cases with a stress testing approach to risk assumptions. Discussion can then focus on the interaction of these risks, identifying “Achilles heel” issues. The range of tabled results or “risk curve” helps to explicitly identify business/risk trade-offs to establish an agreed position and shared understanding of likely downside scenarios and the related financial P & L, balance sheet, and other risk implications. It is the board which sets the boundaries around the business (clients, products, geography, operational platform, etc. – and resultant risk profile) based on these risk trade-offs and provides direction to management about these risk boundaries and business risk tolerance.

Know What You Don’t Know:

Part of every board meeting should be dedicated to “looking out the windscreen not just at the dials” to identify material strategic risks that are inherent with the MFI’s business model. Once determined, this leads to a shared perspective on the key metrics that need to be monitored. There should be periodic strategic updates and discussion on how changes will impact the business of the MFI, with boards asking “what about this?” to raise concerns over politics, over-indebtedness, etc. A well-composed board, drawing on relevant knowledge or experience, should facilitate a collective “reading the tea leaves” to provide an understanding of the larger context within which the MFI is operating. As part of regular business reviews, the board should ask: “What don’t we know?” and with that, “Who should we be asking?” How do we “look out the windscreen” to spot unknown risks, and implement appropriate mitigating actions to minimize surprises?

Risk is Part of the Business:

All financial institutions are inherently in the risk business. Risk is an integral part of the business and should be an aspect of every business discussion and decision. With lending, the upside is interest net margin, while the downside is loss of principal and interest. So, with this, negative gearing risk is at the core of any financial institution’s business model. Risk appetite is determined by looking at projected risk exposure against risk bearing capacity and expected returns.

Some established institutions have set up a formal board risk committee reporting to the board of directors on the institution’s risk profile and risk management framework, including the significant policies and practices employed to manage risks in the business, as well as the overall adequacy of the risk management function.

The changing titles of the Microfinance Banana Skins surveys highlight how the macro risk landscape has changed from a focus on internal management and capacity building risks, to external, macroeconomic, reputation, competitive environment, and on-going relevancy to clients. This is illustrative of the ever-changing context which requires an evolving and collectively understood business model and risk position. This requires boards to take a proactive, holistic, informed, and disciplined approach to setting explicit business and risk boundaries, and monitoring and managing against them. What are our key context and business concerns? What are the risk profile and performance implications? What are the appropriate mitigating actions? Where might we expect surprises? Have we set the tone at the top and appropriate business and risk boundaries?

*Many established MFIs are now regulated financial institutions, with developed and formalized risk and governance practices, so the observations contained within this post are focused more on MFIs that are growing and transforming. 

This post comes from Investing in Inclusive Finance’s forthcoming risk expert exchange. In this expert exchange, 10 industry risk experts each address one tough risk question as Philip Brown has done here. Topics such as over-indebtedness, fraud, “newer” risks, and lack of information will be examined in this risk expert exchange, offering insight on some of the most difficult risk issues that board members face. This publication will be available electronically on the CFI website in the coming weeks.

Philip Brown is Managing Director Risk for Citi Microfinance’s global business. He is responsible for developing the policies, programmes and risk tools to enable Citi’s businesses to commercially engage with microfinance, financial and other institutions, networks and investors, to expand access to financial services in underserved communities. Mr. Brown is a member of the Governing Council of the Centre for the Study of Financial Innovation (UK), the Advisory Council of the Centre for Financial Inclusion (USA) and the Advisory Board of the Council of Microfinance Equity Funds.

Image Credit: KANDEO

Have you read?

Banana Skins 2012: Overindebtedness Tops the Risk Charts

The Psychology of Risk

Risky Business