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Principles of Risk Management in Microfinance

Organization(s): 
microRISK Alliance
Institutional Sponsor: 
United States Agency for International Development

As microfinance has evolved into a more commercialized industry, it has seen itself integrate with international capital markets. In many cases this has led to more sophisticated product offerings, scale of operation, and complexity of financing. Although the dynamics underlying the MF industry have shifted in a very real way, many decision makers still do not fully understand the risks to be managed as financial service actors. Limited risk awareness, risk management, and portfolio transparency continue to remain issues as the industry moves forward into these uncertain times. Over the decades, the non-profit and non-commercial aspects of industry have masked many of the risks associated with providing financial services in frontier markets. Additionally, the global phenomenon of low volatility and high growth rates in emerging markets had further downplayed the incentives to increase better risk management practices.

Since 2008, we have seen the world’s economic environment dramatically change – and the consequences of neglected risk management practices in microfinance have come to light. For example, current outstanding hard currency liabilities on the balance sheets of MFIs are estimated at $3 billion, mostly un-hedged or unmatched with hard currency assets. This specifically demonstrates the lack of currency risk management that has pervaded the MF industry, even as MFIs have gained easier access to hard currency funding. Delinquency levels creeping up by as much as 50% because a reduced inflow of funds are no longer diluting the portfolio-at-risk ratios as before is another example of a situation where MFIs could have prepared for a situation if a proper risk management system was in place.

In essence, access to risk management knowledge and tools is a classic “microfinance challenge”: information and tools that have traditionally been associated with large financial institutions must be scaled down for MFIs that are resource constrained, handling small transaction sizes, and working with low income clients in developing countries. The challenge, therefore, is to bring accessible risk management tools and knowledge to the wider microfinance community – in order to sustain the industry’s growth.

The microRISK Alliance has formulated a set of guiding principles in order to create greater awareness and understanding about risk management and the need for it at all levels.