Microfinance Risk Management Handbook

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<p>MICROFINANCE RISK MANAGEMENT HANDBOOK</p> <p>Craig Churchill and Dan CosterWith Contributions from: Victoria White, Terrence Ratigan, Nick Marudas, Emily Pickrell and Calvin Miller</p> <p>2001</p> <p>TABLE OF CONTENTS</p> <p>Table of ContentsTable of Contents ............................................................................................................... i M Risks M .........................................................................................................................1 Introduction ....................................................................................................................... 2What is Risk Management?....................................................................................................................................2 Structure of the Handbook and How to Use It...............................................................................................4</p> <p>Chapter 1: Risk Assessment Framework ......................................................................... 61.1 Institutional Risks...............................................................................................................................................61.1.1 Social Mission .................................................................................................................................................7 1.1.2 Commercial Mission........................................................................................................................................7 1.1.3 Dependency......................................................................................................................................................7 1.2.1 Credit ..............................................................................................................................................................8 1.2.2 Fraud..............................................................................................................................................................8 1.2.3 Security............................................................................................................................................................8 1.3.1 Asset and Liability .........................................................................................................................................9 1.3.2 Inefficiency .......................................................................................................................................................9 1.3.3 System Integrity ...............................................................................................................................................91.4.1 Regulatory .......................................................................................................................................................10</p> <p>1.2 Operational Risks...............................................................................................................................................8</p> <p>1.3 Financial Management Risks...........................................................................................................................9</p> <p>1.4 External Risks .....................................................................................................................................................91.4.2 Competition...................................................................................................................................................10 1.4.3 Demographic..................................................................................................................................................10 1.4.4 Physical Environment....................................................................................................................................10 1.4.5 Macroeconomic...............................................................................................................................................10</p> <p>1.5 Conclusion.........................................................................................................................................................10</p> <p>Chapter 2: Institutional Risks and Controls...................................................................142.1 Social Mission Risk..........................................................................................................................................142.1.1 Mission Statement.........................................................................................................................................15 2.1.2 Market Research...........................................................................................................................................16 2.1.3 Monitoring Client Composition and Measuring Impact .................................................................................17 2.1.4 Managing Growth.........................................................................................................................................18 2.2.1 Setting Interest Rates.....................................................................................................................................20 2.2.2 Designing the Capital Structure.....................................................................................................................20 2.2.3 Planning for Profitability...............................................................................................................................21 2.2.4 Managing for Superior Performance...............................................................................................................22 2.2.5 Monitoring for Commercial Mission Risk .....................................................................................................23 2.3.1 Strategic Dependence......................................................................................................................................25 2.3.2 Financial Dependence....................................................................................................................................26 2.3.3 Operational Dependence ................................................................................................................................27</p> <p>2.2 Commercial Mission Risk..............................................................................................................................19</p> <p>2.3 Dependency Risk .............................................................................................................................................24</p> <p>i</p> <p>CARE MICROFINANCE HANDBOOK</p> <p>2.3.4 Dependency Risk Controls.............................................................................................................................30</p> <p>Cash Management........................................................................................................................................... 27 CARE Core Costs: PN 85.......................................................................................................................... 27 Institutional Culture........................................................................................................................................ 28 Technical Assistance ....................................................................................................................................... 29 Exit Strategy..................................................................................................................................................... 30 Independent Structure .................................................................................................................................... 31</p> <p>Recommended Readings......................................................................................................................................32</p> <p>Chapter 3: Operational Risks and Controls................................................................... 343.1 Credit Risk .........................................................................................................................................................353.1.1 Credit Risk Controls.....................................................................................................................................35Loan Product Design...................................................................................................................................... 36 Client Screening............................................................................................................................................... 38 Credit Committees .......................................................................................................................................... 42 Delinquency Management.............................................................................................................................. 43</p> <p>3.1.2 Credit Risk Monitoring.................................................................................................................................45 3.2.1 Types of Fraud..............................................................................................................................................46 3.2.2 Controls: Fraud Prevention ...........................................................................................................................48</p> <p>3.2 Fraud Risk..........................................................................................................................................................46Excellent Portfolio Quality............................................................................................................................. 48 Simplicity and Transparency .......................................................................................................................... 49 Human Resource Policies............................................................................................................................... 50 Client Education.............................................................................................................................................. 51 Credit Committees .......................................................................................................................................... 51 Handling Cash ................................................................................................................................................. 52 Collateral Controls .......................................................................................................................................... 54 Write-off and Rescheduling Policies ............................................................................................................. 54 Operational Audit ........................................................................................................................................... 55 Loan Collection Policies ................................................................................................................................. 56 Client Sampling ............................................................................................................................................... 57 Customer Complaints..................................................................................................................................... 58 Fraud Audit...................................................................................................................................................... 59 Damage Control.............................................................................................................................................. 60</p> <p>3.2.3 Monitoring: Fraud Detection.........................................................................................................................55</p> <p>3.2.4 Response to Fraud.........................................................................................................................................59</p> <p>3.3 Security Risk ......................................................................................................................................................60 Recommended Readings......................................................................................................................................62</p> <p>Chapter 4: Financial Management Risks and Controls ............................................... 634.1 Asset and Liability Management..................................................................................................................634.1.1 Interest Rate Risk .........................................................................................................................................64 4.1.2 Foreign Exchange Risk.................................................................................................................................65 4.1.3 Liquidity Risk ..............................................................................................................................................67 4.2.1 Inefficiency Controls .......................................................................................................................................69</p> <p>4.2 Inefficiency Risk...............................................................................................................................................69Budgeting......................................................................................................................................................... 69 Activity Based Costing.................................................................................................................................... 71 Reengineering .................................................................................................................................................. 72 Efficiency and Productivity Ratios................................................................................................................ 73 Monitoring Human Errors............................................................................................................................. 75</p> <p>4.2.2 Inefficiency Monitoring...................................................................................................................................73</p> <p>4.3 Systems Integrity Risks...................................................................................................................................75 Recommended Readings..................................................................................................................................</p>

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