risk management in microfinance banks

HIMS

Rogers A. I. NwokeMD/CEO, HASAL MFB

Presentation at the 6th CBN Annual Microfinance Conference & Entrepreneurship Awards

©HASAL INSTITUTE FOR MICROFINANCE STUDIESHIMS/NAMB Training 2

Concentrate in Class

Obey

©HASAL INSTITUTE FOR MICROFINANCE STUDIES

To understand the reality, concept and source of risks in microfinance

To improve on our knowledge of Risk Management and its impact on microfinance performance

To improve our expertise in applying risk management strategies in our microfinance institutions

To gain competence and skill in Risk Management for the growth of our MFIs


A. RISK MANAGEMENT OVERVIEW Introduction Dimensions of Risk & Risk Management

B. RISK FACTORS & IMPACT ON MFIs

C. RISK MANAGEMENT STRATEGIES FOR MFBs‣ Credit Administration & Control‣ Fraud Prevention and Control‣ Auditing, Compliance and Internal Control‣ Training & Skills Development

D. CASE STUDIES IN RISK MANAGEMENT


What is Risk?

The potential loss an asset or a portfolio is likely to suffer due to a variety of reasons.

defined in ISO 31000 as the effect of uncertainty on objectives, whether positive or negative

Risks can come from uncertainty in financial markets, project failures, legal liabilities, credit risk, accidents, natural causes and disasters as well as deliberate attacks from an adversary.

What is Risk Management? The identification, assessment, and prioritization of risks followed by

a co-ordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities


Credit risk

Loss arising from a borrower who does not make payments as promised. Such an event is called a default

Another term for credit risk is default risk.

Risk that the counterparty will fail to perform or meet the obligation on the agreed terms


Transaction RiskRisk relating to specific trade transactions, sectors or groups.

Portfolio RiskRisk arising from lending to sectors non related to the core competencies of the Bank / concentrated credits to a particular sector / lending to a few big borrowers.


TYPES OF MARKET RISK

Interest Rate RiskRisk felt, when changes in the interest rate structure put pressure on the net interest margin of the Bank. Liquidity RiskRisk arising due to the potential for liabilities to drain from the Bank at a faster rate than assets.


FOREX RISKThis risk can be classified into three types.

Transaction Risk is observed when movements in price of a currency upwards or downwards, result in a loss on a particular transaction.Translation Risk arises due to adverse exchange rate movements and change in the level of investments and borrowings in foreign currency.Country Risk. The buyers are unable to meet the commitment due to restrictions imposed on transfer of funds by the foreign govt. or regulators. When the transactions are with the foreign govt. the risk is called as Sovereign Risk.


Operational Risk arises as a result of failure of operating system in the bank due to certain reasons like fraudulent activities, natural disaster, human error, omission or sabotage etc.Systemic Risk is seen when the failure of one financial institution spreads as chain reaction to threaten the financial stability of the financial system as a whole.Political Risk arises due to introduction of Service tax or increase in income tax, freezing the assets of the bank by the legal authority etc.Human Capital Risk Labour unrest, lack of motivation, inadequate skills, brain drain, etc.Technology Risk Obsolescence, mismatches, breakdowns, adoption of latest technology by competitors, etc, come under technology risk


Credit riskLoss arising from a borrower who does not make payments as promised. Such an event is called a default. Another term for credit risk is default risk. Risk that the counterparty will fail to perform or meet the obligation on the agreed terms

Transaction Risk⇛ Risk relating to specific trade transactions, sectors or groups.

Portfolio Risk⇛ Risk arising from lending to sectors non related to the core

competencies of the Bank/concentrated credits to a particular sector /lending to a few big borrowers.

Sovereign risk Sovereign risk is the risk of a government becoming unwilling or unable to meet its

loan obligations, or reneging on loans it guarantees. The existence of sovereign risk means that creditors should take a two-stage decision process when deciding to lend to a firm based in a foreign country. Firstly one should consider the sovereign risk quality of the country and then consider the firm's credit quality


Lax credit standards for borrowers and counterparties

Poor loan monitoring standards

Poor portfolio risk management

Lack of attention to changes in economic or other circumstances that can lead to a deterioration in the credit standing of a bank's customers


To maximise a bank's risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters.

To establish an appropriate credit risk environment

To operate under a sound credit-granting process

To maintain an appropriate credit administration, measurement and monitoring process

To ensure adequate controls over credit risk.


⇛ Measurement through Credit Rating / scoring⇛ Pricing on a scientific basis⇛ Imposing Exposure Ceilings⇛ Multi-tier credit approving authority⇛ Higher delegated powers for better rated

borrowers⇛ Discriminatory time for credit review / renewal⇛ Hurdle rates / benchmarks for fresh exposures &

periodicity for renewal based on risk rating.⇛ Loan Review Mechanism which should be done

independent of credit operations & administration and cover all the loans above certain cut-off limit ensuring that at least 30 – 40% of the portfolio is subjected to LRM in a year.


LOAN REVIEW MECHANISM : This should be done independent of credit operations & administration and cover all the loans above certain cut-off limit ensuring that at least 30 – 40% of the portfolio is subjected to LRM in a year.


Commercial Loans◦ Short Term – with tenor of less than 1 year usually

repaid through one cash flow cycle◦ Long Term – with tenor of more than 1 year paid

through several cash flow cycles Overdrafts – usually short term in nature to

support cash flow gaps but may be structured as line of credit. They are revolving through out the tenor

Leases – usually medium to long term to support asset acquisition


Seasonal Loans◦ Caused by temporary build up in accounts

receivable/inventory required for normal operations◦ Repayment comes from conversion of that

inventory/receivable to cash after the peak selling season Bridge Loans

◦ Used to fill funding gaps pending next financing ◦ Repayment is made from permanent financing

Project Financing◦ Used for specific financing of capital investments◦ Repayment is from the future cash flows of the project

Lease Finance◦ Used to support asset acquisition◦ Repayment may come from the cash flows of the asset

financed


How will the loan repaid? Primary Source

◦ Will depend on the loan purpose

▶Secondary Source


Who is the

Borrower?

What is the

Purpose of the Loan?

What are the

Repayment Sources?

What are the Risks

& Rewards

?


Cash Conversion Cycle

Cash

Inventory

A/PA/R

Days Sales Outstanding (Receivables Turnover) =

(Receivables $)/(Annualized Revenue $) * 365

Days Payables Outstanding(Payables Turnover) =

(Payables $)/(Annualized Mat’l Cost $) * 365

Days of Supply Inventory (Inventory Turnover) =

(Inventory $)/(Annualized COGS $) * 365

(DSO) (DSI) (DPO)+ -

HIMS

FELIX EMENIKE EJINWA

JULY 2011


DECEIT, TRICKERY; specifically: intentional perversion of truth in order to induce another to part with something of value or to surrender a legal right. An act of deceiving or misrepresenting. Webster Dictionary

“To defraud ordinarily means, to deprive a person dishonestly of something which is his or of something to which he is or would or might, but for the perpetration of the fraud, be entitled.”

7/23/2011Felix Emenike Ejinwa


Fraud can be defined as an intentional Fraud can be defined as an intentional misrepresentation of facts for the misrepresentation of facts for the purpose of obtaining personal gain. purpose of obtaining personal gain.

The above definition exposes three The above definition exposes three key elements that must exist before key elements that must exist before it is concluded that a fraud has it is concluded that a fraud has occurred. occurred.

IntentIntent Misrepresentation of fact Misrepresentation of fact Personal GainPersonal Gain


Some people commit fraud as Some people commit fraud as a result of greed. However, a result of greed. However, there are three key reasons there are three key reasons why fraud occurwhy fraud occur::


OPPORTUNITY OPPORTUNITY

This is the ability to commit fraud, This is the ability to commit fraud, created by weak internal controls, poor created by weak internal controls, poor supervision, abuse of position and supervision, abuse of position and authority. authority.

Failure to establish adequate procedure Failure to establish adequate procedure to detect fraud also creates opportunityto detect fraud also creates opportunity


WHO IS INVOLVED WITH CONTROLS?WHO IS INVOLVED WITH CONTROLS?

YOU

YOUYOU



PRESSURE/MOTIVEPRESSURE/MOTIVE

Pressure can include anything Pressure can include anything including unpaid bills, expensive including unpaid bills, expensive tastes, peer pressure, addition tastes, peer pressure, addition problem e.t.cproblem e.t.c. .


RATIONALISATIONRATIONALISATION

This involves a person This involves a person rationalizing his/her action to rationalizing his/her action to commit fraud i.e. fraud is commit fraud i.e. fraud is justified to save a family justified to save a family member from dying, intends to member from dying, intends to pay back, no help is available pay back, no help is available from outside. from outside.


Fraud can be classified into:

Internal Fraud : committed by employees of the bank

External Fraud: by customers and other external parties

It is also possible for employees to collude with customers and other external parties to defraud the bank.


Cash TheftStealing of cash from the till or vault, thereby

creating a shortage in the books/record

Suppression of customer’s depositCash is collected from customer but not given any

deposit slip, or a deposit slip is issued to the customer but the one to be retained by the bank is destroyed

Fraudulent loansThe supposed borrower is the bank’s employee or

an accompliceForged Documents Forgery of documents to conceal another theft or

fraud


Fraudulent debits into accountsUnauthorized postings into customers’ or

internal accounts Expense ‘Padding’Inflating prices of items to be purchased or under-

delivery of stock Cheque suppressionInward cheques are not debited to customer’s

account within the specified clearing days Electronic Card FraudsFraudulent request to issue electronic card on

customer’s accounts or deliberate linking a customer’s account to another customer’s account.


Stolen chequesCheque leaves are stolen and customer’s signature

forged Forged/Altered cheques Deposit of fake Currencies Issuance of Dud chequesCheque drawn on unfunded accounts Fraudulent loans Card Frauds


Reduced Profit

Damage to Reputation

Reduced customer’s confidence

Low Morale among employees

Cost of Investigation


The key to detecting fraud is understanding thesymptoms. These symptoms are referred to as‘Red Flags’.

Red Flags for fraud by insiders can be grouped into: Personality Traits Domineering/Controlling Don’t like people reviewing their work Strong desire for personal gain “Beat the system” Attitude


Living beyond income level Close relationship with customer/vendors Don’t take vacation Outwardly, appear to be trustworthy

Situational Pressure Medical Problems – especially for a loved one Loss of job by spouse Divorce/Marital Problems


Need to maintain a certain lifestyle Addiction Indebtedness

Behavioral Changes Suddenly appears to be buying more material

items Carry unusual large amount of cash Creditors showing up at work place Borrowing money from coworkers Becomes unreasonably upset when questioned


Others

Unexplained difference in account reconciliation Improper recording of transactions Missing documents Duplication Unsupported or unauthorised documents


Fraud is a crime and the best means of prevention is to understand why it occurs.

Fraudsters generally identify an opportunity for exploiting a weakness in the control procedures and then assess whether their potential rewards will outweigh the penalties should they be caught.


Prevention of fraud is a two stage process:

ensure that opportunities for fraud are minimised, (fraud prevention), and

ensure that potential fraudsters believe they will be caught, (fraud deterrence).


TRAITS SHARED BY MOST FRAUDSTERS

Male Intelligent (challenged by “secure” systems, bored with the job

routine) Egotistical (scornful of "obvious" control flaws, "dumb" managers,

etc.) Inquisitive (tempted by the discovery of a computer vulnerability,

for example) A risk taker (willing to bend the rules, take chances) A rule breaker (takes short cuts, self-justifies infractions of law,

rules, etc.) A hard worker (first to arrive in the morning, last to leave at night,

takes few vacations) Under stress (suffering from a personal crisis, such as a financial

problem, bad marriage, etc.) Greedy or has a genuine financial need (illness, drugs,

gambling, etc.) Disgruntled at work or a complainer

(may try to "get even", or take what he/she "really deserves") A big spender (expensive hobbies, living beyond means)


The Don’ts: Don’t take anything for granted. Don’t volunteer confidential information over the

telephone/telex/fax unless you know and trust those who are inquiring.

Don’t allow customers to pressure you into making impulsive decisions.

Don’t give value against uncleared payment items. Don’t accept third-party cheques from new customers without

a senior manager’s authorization. Don’t cash cheques for strangers. Don’t transfer funds without first obtaining proper

authorizations. Don’t discuss internal operations or systems with outsiders. Don’t write to suspicious individuals on company stationery. Don’t be afraid to contact the police if you have suspicions

about certain customers and their respective business dealings.


Be Cautious Always resist promises of inordinately high returns and

guarantees of endless supplies of funding. Nothing ever comes for free. Think twice when you are presented with confusing

business proposals or when potential business partners supply vague answers.

And should you ever be requested to provide letters printed on your company letterhead, outlining potential new business relationships, always decline.

Remember, you are the only one who can save yourself from fraud.


The average person is totally unaware of the magnitude of fraudulent activity that occurs on an ongoing basis. Having gone through this workshop to this point, you should understand its far-reaching effects and be able to better identify examples of this crime.

It cannot be emphasized strongly enough that unfamiliar companies need to be investigated thoroughly if you are contemplating a business association with them.

Walk away from questionable activities: never be afraid or too embarrassed to immediately report them to your local police departments. These authorities are there to help you to deter new and repeat offenders. They receive regular updates on successful and unsuccessful frauds, and will often recognize a particular fraudster’s method of operation.


Anticipate criminal activityIf you become suspicious of a recently established business relationship,terminate it. Companies can appear straight-forward at the outset. Once

theyhave earned your trust, they may subsequently initiate criminal activity.

Similarly, terminate long-term business dealings with associate companies if management, for some reason, begins to act abnormally. Take nothing for granted.

Also, be cautious of those approaching you professing to represent legitimatebanks. If they offer to deal with your company and you are unfamiliar with

theirfinancial institutions, refer to such publications as the Bankers’ Almanac, etc

which can be found at local library. They list all the major international banks, their histories,ownership status, and assets and liabilities.

Above all, remember, if a deal looks too good to be true, it very likely is – and usually involves fraud.


Training ◦ Management Associates◦ Operations/Control staff◦ Marketing/RMs◦ Credit Officers◦ Management

Sharing experience with/of other Financial Institutions

Learning from experiences Selectively fighting back (but …. CARE?)


Learn from our mistakes (and from the mistakes of others) Run training courses – Fraud Awareness for Bankers in all

jobs. Maintain specialist investigation teams Maintain a Network of Contacts (“I know a person..”) Ensure that bankers remain professionally skeptical and are

never too embarrassed to say “I do not understand” Deal quickly, thoroughly and efficiently with all cases,

hitting the Fraudsters where it hurts most (in their wallets) Design fraud out of a systems and processes.


Accounting and Procedure Manual

Local Policies and Procedures

Credit Manuals

System Manual

Desk Manuals

What Are The Tools Available To Perform The Control Functions?


Operating Losses

Reporting Errors

System/Dev. Fiascos

Corporate Embarrassment

Fraud

WHAT HAPPENS IF WE HAVE POOR CONTROLS?


The compliance The compliance departmentdepartment

The businessThe business

The Regulators & FraudstersThe Regulators & Fraudsters

Business and Compliance must work together to avoid Business and Compliance must work together to avoid regulatory & reputation sanctions and Fraudsregulatory & reputation sanctions and Frauds


Internal Audit & Control Function

Internal audit being an integral part of banks internal control system functions as an independent, objective assurance and consulting activity designed to add value and improve the banks operations.

It is a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and corporate governance processes.

Internal audit reviews and ensures integrity of information, compliance with policies and regulations, safeguarding of assets and efficient use of resources.

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Independence of Internal Audit Function & Ethics

To function as the main machinery for the maintenance of internal controls, the auditor must be independent and given unrestricted access to information and records.

He should report directly to the Board Audit Committee and also administratively to the MD/CEO as well as coordinate audit activities with external auditors and examiners (CBN/NDIC).

High premium is placed on effective staffing of the internal audit department with highly skilled, competent, and independent people of high integrity.

The internal auditor is not expected to perform operational duties and his performance should not be based on profit or revenue goals.

His independence therefore facilitates his functional role for safeguarding assets, ensure compliance with internal policies and procedures as well as laws and regulations.

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Summary & Conclusions

•The role of independent, competent and qualified auditors facilitates the internal control function which are vital to the corporate governance process in order to achieve the objective of safeguarding stakeholders’ interests.

• In particular, internal auditors should facilitate the control function to provide an independent check and assurance on the information received from management on the operations and performance of the bank.

• This goes a long way in determining the long-term soundness of the bank to sustain the going concern.

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Questions & Questions & IssuesIssues

risk management in microfinance banks

Documents

average time

strategic supply chain

multiple supply chain

days of funding

supply chain cultural

number of days

free cash flows

shortest possible time