SPECIAL REPORT: A Risk Management “Graduation Model” for Microfinance

MicroCapital: You will be speaking in a few days at European Microfinance Week. How will you describe the state of risk management within microfinance and where it fits in the broader context of the industry?

Kevin Fryatt: In the last several years, we have seen a lot of focus on new technology and serving clients better through new product development, savings mobilization and agent networks, amongst other avenues. Similarly, institutions’ balance sheets are getting increasingly diverse in the types of funding they are sourcing. But within this, the conversation of risk management isn’t happening. There’s a sense of cynicism within the leadership of microfinance institutions (MFIs) toward risk management. It is often misunder-stood and confused with the roles of internal audit or compliance. It is often very difficult to quantify the value of risk management.

If we look at the incentives for good risk management, what we generally see are institutions engaging in more formal risk management, number one, because it’s a requirement of the regulator to get a deposit-taking license, as opposed to thinking, “We are going to be taking deposits, and there are new and challenging risks from a funding and reputational perspective that go along with raising deposits.” The other piece is from funders, who may tell an institution, “Okay, we would like to see ABC in place, and we are actually willing to give you some financial resources to make that happen.” In order to get the financing, an institution will then engage in the technical build-out of a risk management function, yet there might not be the political will within the institution to really engage in this in a sustainable and effective way. Having an institution pay entirely out of its own resources to improve this function is quite rare.

MC: What do you consider the key elements of risk management for an MFI?

KF: The fundamentals that we consider first and foremost are institutional culture, risk management governance, internal control structures and having a management information system (MIS) in place that can collect data in a way that helps an institution quantify these risks. We see a lot of underperforming MISs that aren’t producing timely data or data that are of high enough quality for analysis. Without that, conducting formal risk management is very difficult.

MC: How do these fundamentals relate to the Graduation Model that the Risk management Initiative in Microfinance (RIM) is developing?

KF: There are relatively sophisticated approaches that are being proposed, and then there is the reality of where MFIs currently are. The idea behind the Graduation Model is that we need to develop formalized and appropriate risk management standards for institutions in different levels of development. Within the Graduation Model, we are developing a diagnostic process that can identify what “tier” the MFI is in, and then its staff will be able to score the institution’s adherence to the standards for its tier. This will help MFIs have conversations about the future and what their risk management requirements should be as they grow. Within the strategic planning process, this will allow them to start proactively allocating resources and getting staff skill sets prepared or hiring new staff as they prepare for the future.

In some instances, institutions that have fairly large balance sheets – and might be looked at as Tier-1 institutions from an asset standpoint – are living up to only Tier-3 standards from a risk management standpoint. Recently in Ghana, I have seen reports that anywhere from 50 to 60 microfinance institutions have collapsed since 2013. And some of that, fundamentally, has to do with risk management. In Uganda, the same thing is happening: I’ve had conversations with the association of microfinance institutions there, and risk management is one of its top concerns.

After MFIs use the Graduation Model to make strategic decisions about where they want to build out capacity, they can engage whichever technical service provider they wish to support them. Or they can approach technical assistance facilities to assist with co-financing and sourcing consultants. A lot of the skills in the risk management space come from the West and bring a fairly expensive price tag. To address this, RIM endeavors to facilitate the training of a pool of local talent, so an institution in Kenya, for example, can engage with folks locally or regionally, which can ultimately reduce the cost to the institution.

MC: How can our readers participate in this process?

KF: The Graduation Model will be released to the public for free on our website in time for European Microfinance Week, which begins November 12. We are inviting organizations to become members of RIM, be part of our governance structure and join our working groups. One of those is our technical working group, which is primarily responsible for building out these standards. Also, we are actively looking for highly influential people in the industry who understand the core issues that face the industry as well as senior-level risk management experts who can help advise RIM both from a strategic standpoint as well as from a technical standpoint. We are currently piloting the Graduation Model in a number of MFIs around the world, and we are continually looking for additional MFIs to participate.

Kevin Fryatt is the Director of US-based RIM, which was founded in 2013 by ADA, Calmeadow, the Center for Financial Inclusion at Accion, MEDA, Microfinanza Srl, MFX Solutions, Oikocredit and Triple Jump.

This sneak preview of European Microfinance Week is sponsored by the European Microfinance Platform (e-MFP), a 130-member network located in Luxembourg.

Additional Sources and Resources:

European Microfinance Platform (e-MFP) to Host European Microfinance Week, November 12-14, 2014, With On-site Reporting by MicroCapital

More coverage of European Microfinance Week and the Action Groups of the European Microfinance Platform (e-MFP)

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