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  • Managing Microfinance RisksSome Observations and Suggestions

    Nimal A. Fernando

    About the Asian Development Bank

    ADBs vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries substantially reduce poverty and improve the quality of life of their people. Despite the regions many successes, it remains home to two thirds of the worlds poor. Nearly 1.7 billion people in the region live on $2 or less a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance. In 2007, it approved $10.1 billion of loans, $673 million of grant projects, and technical assistance amounting to $243 million.

    Asian Development Bank6 ADB Avenue, Mandaluyong City1550 Metro Manila, Stock No. BBK161208 Printed in the Philippines

    About Managing Microfinance Risks

    Risk is an integral part of financial intermediation. Hence, risk management must be at the heart of finance. However, systematic risk management is still not as widespread as it should be in the microfinance industry. Except for a few flagship microfinance institutions (MFIs), which constitute the industrys core, risk management is often overlooked by most MFIs, who seek growth. To serve a majority of the poor and low-income households on a sustainable basis, MFIs, including those interested in agricultural microfinance, must build their internal structures and capabilities for risk management. However, it is important to recognize that modern technical tools and analysis cannot help achieve effective risk management in respect of nonagricultural or agricultural microfinance if it is not embedded in the institutional culture and valued by everyone. For most MFIs, achieving this goal remains one of the most challenging tasks in risk management.

  • Managing Microfinance RisksSome Observations and Suggestions

    East Asia DepartmentJuly 2008

    Nimal A. Fernando

  • Reprinted with permission from the Asian Journal of Agriculture and Development, Vol. 4, No. 2.

    Nimal A. Fernando is Practice Leader for Microfinance in the East Asia Department of the Asian Development Bank (ADB).

    The views expressed in this paper are those of the author and do not necessarily reflect the views and policies of ADB, or its Board of Governors, or the governments they represent.

  • Abstract

    Risk is an integral part of financial intermediation. Hence, risk management must

    be at the heart of finance. However, it is disturbing to note that systematic risk

    management is still not as widespread as it should be in the microfinance industry.

    Except for a few flagship microfinance institutions (MFIs), which constitute the

    core of the industry, most MFIs do not pay adequate attention to systematic risk


    The microfinance industry has grown rapidly during the last decade in breadth,

    depth, and scope of outreach. The rapid growth seems to continue, given the

    massive unserved and underserved market. The growth of the industry has changed

    the risk profile of MFIs. Yet many MFIs seem to continue to seek growth without

    much attention to attendant risks. Surprisingly, many MFIs appear to neglect even

    the basic credit risk management which helped MFIs achieve high growth rates


    The growing interest of many MFIs in agricultural microfinance must be seen

    in the broader context of risk management in the industry. Financing agriculture

    is more risky than financing trade or industry; it is also more risky than financing

    nonagricultural microenterprises. However, MFIs interested in agricultural

    microfinance should be more concerned about their internal structures and

    capabilities rather than the widely discussed, and often cited, pervasive risks in

    agriculture and their ramifications for the MFIs pursuit of growth in agricultural


    MFIs should recognize the inherent risks in agriculture. However, if they build

    their institutional capacity to effectively deal with risks generally associated with

    financial services for poor and low-income households, their prospects for success in

    agricultural microfinance would certainly be much brighter. In addition, no amount

    of sophisticated and modern technical tools and analysis can help achieve effective

    risk management in respect of nonagricultural or agricultural microfinance if risk

    management is not embedded into the institutional culture and its value is not


    shared by all employees. Achieving this goal remains one of the most challenging

    tasks in risk management which MFIs need to address. To help in this effort, we

    need to bring into the discussionnow dominated largely by issues related to

    introducing sophisticated systems and technical tools of risk managementthe

    institutional cultural issues and issues related to cognitive biases in executive

    decision-making behavior.


    IntroductionThe breadth, depth, and scope of outreach of the microfinance

    industry have grown significantly during the last two decades.

    The Asia and Pacific region accounts for the bulk of this growth.

    According to the Microcredit Summit Campaign (2006:24), by

    31 December 2005, some 3,133 microcredit institutions reported

    reaching 113.26 million clients with a current loan, and about 97

    million of these clients were in the Asia and Pacific region. Of the

    total number of clients reached by these institutions, about 82 million

    were among the poorest when they started with the program, and

    91% or about 74 million of the poorest families reported are in Asia

    where over two thirds of the worlds poor people live. The erstwhile

    microenterprise-credit-only institutions are now providing a broader

    range of credit products. Their loans are no longer confined to short-

    term working capital loans but now also include loans with relatively

    longer maturities, and those intended for other purposes such as

    acquiring fixed assets. Some microfinance institutions (MFIs) even

    venture into the financing of agricultural operations. Other MFIs have

    expanded their deposit services, thus contributing to the expansion

    of the scope of outreach. Grameen Bank, for example, has achieved

    impressive results in mobilizing voluntary savings through its new

    deposit products offered under the Grameen Pension Scheme to the

    members, and other deposit products offered to both members and

    nonmembers (Rutherford 2006).

    The last two decades have also seen a significant increase in the

    diversity of institutions providing financial services to the poor and

    low-income households. The previous predominance of non-

    government organizations (NGOs) in the retail markets of many

    countries has been challenged by new developments such as the

    transformation of some pioneering NGOs into fully or partially

    regulated financial entities, the emergence of specialized

    microfinance banks, the entry of commercial banks into

    microfinance, and the increased involvement of cooperatives and

    rural banks. The increasing involvement of nonfinancial institutions

    such as telecommunication companies in microfinance is adding to

    this diversity.


    One of the significant changes in the microfinance industry has

    been the growth in commercial and semi-commercial borrowings,

    including loans denominated in foreign currency to finance operations.

    According to Abrams and Stauffenberg (2007, p. 1), in the last

    3 years, the volume of international private lending for microfinance

    has exploded: in 2005 alone, outstanding loans doubled to nearly

    $1 billion. Structured finance transactions are also becoming

    important in the microfinance market. In 2006, Bangladeshi MFI

    BRAC securitized the $180 million equivalent of its portfolio.

    As will be shown later, although MFIs and the industry have

    suffered serious setbacks in some countries, the industry has been

    relatively stable in most countries. A number of institutions such as

    BRAC and the Association for Social Advancement in Bangladesh,

    the SKS Microfinance and Spandana in India, and the Compartamos

    in Mexico have managed to sustain their growth rates remarkably

    well without sacrificing portfolio quality. The incredible resilience of

    the industry was illustrated during the Asian financial crisis in the

    late 1990s and the aftermath of the tsunami which struck Asia in

    2005. However, it must be recognized that the changes in markets,

    products and services, delivery models, and technology used in the

    industry have had, and continue to have, profound implications on

    the overall risk profile of the industry over time. MFIs or others which

    provide microfinance services can no longer afford to focus only on

    credit and liquidity risks and consider other types of risk on an ad

    hoc basis, often in a reactive manner. Risks in microfinance must be

    managed systematically and the importance of risk management will

    further increase as the


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