SUMMARY OF THE PAPER 10 RISK QUESTIONS FOR EVERY MFI BOARD

Prepared by: Githin Thomas (12sdp705) & Kirti Chandra (12sdp706) Group: 6

Background
The paper titled Ten Risk Questions for Every MFI Board by Center for Financial Inclusion (CFI) highlights the importance of risk governance in MFIs (Microfinance Institutions). For formulating this Paper CFI asked questions related to risks in MFI to 10 microfinance experts. The answer to questions by the experts gives a clear cut idea board involvement in risk conversation, emerging risks, contingency plan for potential risks, risk management measures, risk management through technology, risk identification, measures to overcome client over-indebtedness, main risk responsibilities that board fail to address and efficient risk strategy and appetite .The views of these experts provides a concrete suggestion of warning signs and strategies for effectively managing or avoiding risks to board members of MFIs. The views of the experts for the ten topics related to risks are detailed below:

1. Involvement of Board in Risk conversation

Although MFIs begun to decentralize risk management in recent years, the involvement of board in risk conversation is still largely silent. This lack of attention to risk is not evolving from lack of interest. This is because of the following factors: Confusion of division of responsibility between board and management Lack of differentiation of methodologies ,tools and techniques according to degree of degree of Institutional development and sophistication of MFIs Quantitative involvement of board in risk management

To cross the above factors board should involve in the risk conversation more proactively. They should find out right tools, procedures and outside help from corporate risk literature and tools to share beast practices in microfinance industry. The board also requires a formal and regular updates pertaining to risk, the regulatory frame work and compliance to improve the channel of communication between directors and senior managers, and correct identification, monitoring and triggering guidelines at the board level to amplify and complement effort of the risk management unit. Moreover board should involve in risk management more qualitatively. Involvement of board in risk management in quantitative way excludes the board from much day to day risk conversation. So to involve the board in risk conversation, the directors should elevate the risks that are bottom of the risk managers priorities. This bottom priority risks include political, regulatory and external shocks risks. These risks need a clear integrity and direction at top. So this will give an opportunity to board that will make their role in risk more qualitatively.

2. Newer Risks Board be aware off

Newer risks always impact the company and MFIs in some way. These risks can be defined in following way: Risks that have an increase severity Risks that have increase frequency Risks that are new

Two significant new risks that boards of MFIs should be aware include reputation risk and new technologies. Reputation Risk: Always Boards of respective MFIs should be proactive about positive and negative informations that can impact organization reputation. Otherwise this positive and negative information

will spread instantaneously through communication channel and will affect the reputation of the organization. So if this headline risk is unhandled, the flow of fund from lenders and donors will decrease drastically. New Technologies: Adoption new technologies by the organizations always lead to emerging of new risks .For example, mobile and agent banking as product delivery channel by many MFIs lead to following risks Failure to get qualifying agents in rural areas where many operations are carried out Reduction in weekly group meetings and which lead to the reduction in client closeness. Product or technology challenges and errors aroused due to unfamiliarity of clients with electronic banking.

3. Contingency Plans for Variety of Potential Risk Scenarios

The performance of an organization when they are in the crisis and when they are not are totally different. So to tackle this crisis they should have a plan in place. They should formulate these plans by involving all the board members in strategic and annual planning process. Example of these plans includes Continuity of Business Plans (COB) and Continuity of Funding plans (CFP). Continuity business plan is a plan to keep the business going during an unexpected crisis or event. For execution of the COB, all the management and staff should know what they should do in crisis. Continuity of Funds Plan is used during the disruption of the funding to continue the business as usually. MFIs should prepare in two levels: 1) CFP for disruption of funding limited to their institution and 2) CFP for disruption of funding for a large market event like natural disaster or political event. To formulate these plans MFIs always should conduct stress tests. This will help to anticipate potential negative impacts of any changes and agree. Moreover MFIs should continuously monitor the macro indicators and this will help them to change the plan according to the change in business environment.

4. Risk Management Measures a Board should focus on

The most important risk management measures that board should focus on falls on three categories like defining target markets, establishing clear goals and setting risk tolerance limit. Target markets can be defined based on indicators like average level of client income, average sale of client business rural or urban market and type of business. The goals should be established in a way to achieve both financial and social objectives since these goals are function of double bottom line orientation of microfinance institutions. Risk management measurement related to goal includes size of portfolio, asset quality, profit margin and growth rate. Board should set the tolerance limit not only for the credit extension but also for the enterprise risk including liquidity, market and reputational risks. Important tolerance limit with respect to credit exposure includes maximum and minimum exposure per customer, maximum exposure per group, maximum exposure per economic group and maximum exposure per type of credit.

5. Technology Help in Managing Risks

Technology cannot manage the risk at all but it can be used as a facilitating tool. As a facilitating tool it is absolutely necessary in portfolio risk management. In portfolio risk management the MFI management easily miss the emerging risks if they depend on basic delinquency report. They should have an insight to find out the driving trends and hiding factors. For this good portfolio insight we need standard good technologies. But to use this technology effectively MFIs should have a good data collection, a solid analytical platform and good risk managers.

6. MFIs fraud Identification and Prevention

For Identification of the fraud, MFIs should:

create a culture of transparency and integrity among staff members and clients and Educate the clients on their rights and ensure there is a mechanism of Whistle blowing.

Transparency can be achieved by providing a platform where client can speak effectively and also by promoting client feedback. The complaints of the clients should analyze periodically to find out trends and red flags. MFIs should also use customer forums, market research, and client satisfaction surveys for identifying the causes of fraud. Operational spot checks should conduct regularly to find out fraudulent transactions. Monitoring system should implement in such a way that supervisor continuously check out the work of subordinates. Financial audits and methodology should use effectively for identification of frauds. MFIs should establish Subcommittee at board level to check the risk reports, specific ratios and variance. For preventing the fraud there should be clear policies for all operation of MFIs. This include policies and procedures for credit processing, approval and disbursement of limit for each level cash handling, IT, delinquency ,purchasing or buying, rescheduling and writing of loan. Operational policies should clearly say segregation of duties and human resource policies should outline what constitute fraud, how fraud cases are treated and penalties for different fraud activities. Moreover MFIs should create recruitment policy to ensure that people with integrity are hired.

7. Preparation of MFIs for Risk Identification

By the help of a well functioning risk management system, expertise and skills to process the risk information appropriately and rising of awareness among all employees MFIs can ensure that necessary information about risks are identified. Institution should execute some regular activities to ensure risks are identified and information is collected. Risk assessment is a good example of this regular activity where business and risk experts can review current business processes to identify possible gaps that would allow risks to materialize. New risk approval process is another way to identify the risk. But this process is in the pipeline of implementation for new products, process or system. Another tool is a risk event management system, which ensures professional management of risks once they have materialized. After the implementation of risk identification, Institutions should have qualified people to evaluate the severity of the risk identified and then to support management for taking appropriate measures to deal with risks. Lastly without fail MFIs should raise awareness and understanding about risk and risk management in institution. For this they should conduct regular training for all whom working in the organization.

8. Factors Leading to client over-indebtedness and Preventative Measures

Competition is the main factor which is leading to Client over-indebtedness. This competition will broadens product offering and services, benefitting the end user. But when the desire of lenders will cross the limit the debt of borrowers will increase and as a result cycle of over-indebtedness will start. Character of the client is the factor related to over-Indebtedness. Capacity will vary from client to client but it is the character that prevents the client from getting into too much debt. So MFIs should take proactive measures to prevent over-Indebtedness among the clients. They should keep the willingness to pay of the client always high. For this they should keep the consistency in collection through constantly monitoring client through tools and payment systems. They should portray a message that if client is doing well, then he or she will receive the loan in future. Moreover MFIs should promote client education in order to foster loyalty and willingness to pay.

9. Main Risk responsibilities that Board Fail to Address

Involvement in MFIs actively is one the risk responsibility board members always fail to address. For this they should participate in more meetings, pay visit to institutions and test the product MFI is offering. Changing of the nature of the board member from defensive to approachable, acceptations of personal limitations and use them to involve more experts, making sharp decision when a specific

risk do not go as expected, maintaining a positive relation with regulators and taking decision to stepdown and free the space for someone if there are more challenges are the main risk responsibilities all the board members fail to address. The high willingness that the board members should have to identify the challenges that are shared among all members in all sector of the country is the another risk responsibility that board member always fail to address. To address this issue they should use the social networks like to contact other board members and share questions and concerns.

10. Methods to Explicit about Risk strategy and Appetite

Board should follow some on-going risk guiding principles to being explicit about risk strategy and appetite. These guiding principles should cover setting of risk culture, creating risk boundaries, know what you dont know and realization of risk is a part of business. Risk culture can be set up by matching MFI performance against the expected performance of shareholders and stakeholders. This culture should be in a way that it should trickle down throughout the entire institution i.e. .from board to management to the individual, daily staff decision. Board should create the boundaries around the business based on the risk-trade off. These boundaries should be set across clients, products, geography, operational platform etc. These boundaries should provide direction to management about business risk tolerance. Board also should conduct strategic updates and discussion regularly to know how changes will impact the business. Lastly board should consider risk as an integral part of business and should be part of every discussion and decision.