>By Danielle Donza
My mother is a risk expert. Even now, when she walks into a room, she sees the choke-able object on the floor, the sharp corner of the coffee table, and the window open just enough for a baby to fall out. Sometimes I think she sits around all day dreaming up every risk her children could possibly face, no matter how absurd, and figuring out how she can prevent it. Some would call this paranoia, but some might call it risk management.
Whether it’s childrearing or MFI oversight, risk management is tricky business. It requires identifying plausible risk scenarios, deciding which risks are actually worth focusing on, understanding what you can do to mitigate them, and finding a balance so growth and development aren’t (too) negatively affected. And, for MFIs, it requires reaching consensus among board directors and management on an acceptable level of risk, and then complying with regulations, especially if taking deposits. Mom had a hard enough time getting Dad to agree, and comply.
In the Center’s recently released “Microfinance – A Risky Business ,” David Lascelles, senior fellow and joint founder of the Center for the Study of Financial Innovation, shares his insights about risk in a lively and provocative manner. He discusses some of the most important risks that boards should consider and highlights the importance of managing risk at all times, not just during crisis. In fact, effective board oversight of risk should help to anticipate and avert crises.
A recent article in the Harvard Business Review, “Managing Risks: A New Framework” discusses the need to stop thinking of risk management as a rules-based compliance issue and start to recognize some of the complexities behind managing risks – many of which delve deep into human psychology! The article also provides a helpful framework for thinking about risks by categorizing them into the three buckets of Preventable, Strategy, and External. For microfinance, Preventable risks would include fraud, bribing of local officials, etc. and should be managed through rules-based compliance. Strategy risks would include unsecured lending to financially insecure clients and can be managed by creating “risk report cards” and a culture of questioning and playing devil’s advocate. Finally, External risks such as natural disasters, wars, or a global financial crisis are best-managed through stress testing and scenario planning.
For instance, the pressure to meet ambitious growth targets and match tough competition carries with it the risk of deterioration in lending practices, if credit standards are not followed or staff are recruited and trained in haste. Every lending organization takes on credit risk deliberately as an inherent part of its daily business. The challenges are to avoid credit risk escalation due to lax control systems (preventable risks), deliberate prioritization of rapid growth (strategic risk), or a sudden economic recession (external risk).
Ultimately, an MFI’s board of directors holds the responsibility of providing adequate risk oversight and guidance, and the board also has the unique opportunity to affect institutional change at many levels — strategic, financial, organizational, and operational — all of which hold risks to the institution, and the industry. Yet, as a board director not involved in the day-to-day management of the institutions, it is hard to know the warning signals you should look for, the questions you need to ask, and how to evaluate the information that is being provided to you.
And this becomes even more difficult when everything seems to be going well – with growth, new product lines, profit – and no one else seems worried.
Given how difficult risk management is and how many other issues compete for boards’ attention; I guess it is no surprise that in recent Microfinance Banana Skins reports, weak risk management capability emerged as a key concern for MFIs, investors, and other industry actors. While tools and training in risk management often exist for the MFI’s staff and managers; the ultimate guardians of the financial health of the institution, the board of directors, are often distant from these efforts.
By clearly outlining the board’s role in risk management at MFIs, and developing risk management training materials and resources, the Running with Risk project aims to create a common framework and language around risk so both the MFI’s management and board of directors understand their roles and can more adequately anticipate and manage risks. Lascelles’s paper is the first in a series of risk management resources emerging from this project, and it is meant to increase board members’ risk management knowledge.
The Center is grateful for the intellectual contributions of Citi Microfinance, and to Citi Foundation for its generous support of the Running with Risk project. The goal of the Running with Risk project is to raise awareness about the importance of effective risk governance for institutional growth and sustainability, and to develop the resources, tools, and trainings, needed to improve the risk management abilities of MFI board members and the quality of the their risk dialogue between with management.
An alignment of thinking around a simple framework for risk management will result in a more productive board room dialogue about risk, and will provide the approach for effective institutional risk management at the board level. Ultimately, a stronger, more effective board focus on risk mitigation will contribute to the health of MFIs by creating more stable, secure financial institutions.
Image credit: pinkpeppers.com
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