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INTRODUCTION TO RISK MANAGEMENT

3rd September 2008

INTRODUCTION TO RISK MANAGEMENT OBJECTIVE


TO REVIEW AND UNDERSTAND THE GENERAL AREAS OF RISK FACING MFIs AND HOW MICROFINANCE INSTITUTIONS SHOULD MANAGE THESE RISKS TO REVIEW AND UNDERSTAND THE SPECIFIC RISKS FACING MFIs WHO ARE GRANT RECIPIENTS TO DISCUSS AND AGREE THE RISK MITIGATION STRATEGIES IN EACH RISK AREA USED IN TRACKING, ASSESSING, AND OVERCOMING ISSUES ARISING

Session 1: THE GENERAL AREAS OF RISK FACING MFIs


What is risk? Risk is a concept that denotes (1) a potential negative impact to (2) some characteristic of value that (3) may arise from a future event. Exposure to the consequences of uncertainty constitutes a risk. In everyday usage, risk is often used synonymously with the probability of a known loss.

What is management? Basic functions of management: Management operates through various functions, often classified as planning, organizing, leading/motivating and controlling. Planning: deciding what needs to happen in the future (today, next week, next month, next year, over the next 5 years, etc.) and generating plans for action. What to do if the risk event arises? Organizing: optimum use of resources to successfully carry out of plans Staffing: recruitment & hiring individuals for appropriate jobs Leading/Motivating: exhibiting skills in these areas for getting others to play an effective part in achieving plans Controlling: monitoring - checking progress against plans, which may need modification based on feedback

What are the risks that microfinance institutions face? The 7 main areas of institutional-level risks facing MFIs are often agreed to be in the areas of: Credit Risk Liquidity risk Market risk Operational risk Interest risk, Foreign exchange risk, and Environment Compliance & Regulatory risk

WHAT IS RISK MANAGEMENT? Answer: Risk management is a dynamic process of:


identifying risks, measuring risks, establishing limits for them, assigning responsibility for and monitoring risks, taking action to offset unfavourable scenarios, and adjusting these risk levels for new information and an institutions changing business

Diversification is key to minimizing overall risk

WHAT IS THE PURPOSE OF RISK MANAGEMENT FOR MICROFINANCE INSTITUTIONS? Answer: from a financial institutions perspective, the purpose of risk management is to:
protect the institution from losses (minimize the downside to the MFI); attract capital; and instil confidence in regulators

All financial institutions should strive to inculcate a Risk Management Philosophy / Approach in their institutions: this is an organisational culture

How do MFIS manage risk? In practice microfinance institutions manage risk in various ways, such as: Planning: This includes longer-term strategic & business plans (3 to 5 years), annual
business plans, activity and workplans. The detail will relate to complexity & scale of the MFI Monitoring progress against plans: this means having the information (often refered to as management information systems or MIS) to track data that will enable progress against the plan to be monitoried. MIS and Data Collection is a key ingredient in managing risk and cannot be over-emphasized.. it enables an MFI to model volatility scenarios and test the sensitivities of financial projections to varying factors:
Interest rate movements Foreign exchange rate movements Core deposits Foreign exchange trading volumes (to provide insight into the liquidity of foreign exchange and access to it) Trading of securities (to help determine the liquidity of investments).

External auditing: independent advice to the highest governance body in the


microfinance institution, to management, to regulatory and to consumers. This is mainly to ensure that the financial position of the microfinance institution is transparent.

Internal audit function: Regulatory compliance: Independent governance: Tracking client satisfaction (such as through surveys) and developing products that meet their needs. Systems development, including standardisation, such as operations manuals. Staff development & training, and performance tracking Liquidity management: as minimum policies for min cash levels must be in place.

Assessing risks: MFIs face different risks over time, and levels of risk change. So efforts & resources should aim at risks that: more likely to occur: so have a high probability; risks that will have a bigger impact on the microfinance institution

Session 2: THE SPECIFIC RISKS FACING MFIs WHO ARE GRANT RECIPIENTS What are the major risks relating to provision of grant funds to MFIs? List on a poster sheet and discuss The largest risk is the grant recipient MFI collapsing!

One approach the project, BoL and ADB use in managing risk has been through eligibility criteria This is confirmed through a DUE DILIGENCE process (see Annex to GF Manual)
Reminder: MFIs must: in operation for at least six (6) months be registered with the Bank of Lao PDR, or in the process of registration have at least two full-time paid staff contribute matching capital at least equal to the amount applied for have staff capable of preparing regular and periodic financial statements in accordance with BOL requirements submit a business plan for a minimum period of two years comply with the Microfinance & SCU Decrees Demonstrate competency and good record keeping Provide names of major shareholders, directors and employees together with evidence of capacities and qualifications

Session 3: THE RISK MITIGATION STRATEGIES IN EACH RISK AREA USED IN TRACKING, ASSESSING, & OVERCOMING ISSUES ARISING

What are each of the risks & potential impacts of these risks? For each Risk area identified, discuss & agree likelihood / consequence / risk level For each Risk area identified, discuss and agree treatment to mitigate that risk area For each Risk area, discuss and agree action to be taken if the risk occurs Determine who is responsible for each Risk area identified. Add any comments / notes if relevant

ANY OTHER QUESTIONS / DISCUSSION THANK YOU!

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