Risk Management inMicrofinance Banks Rogers A. I. Nwoke MD/CEO, HASAL MFB Presentation at the 6th CBN Annual Microfinance Conference & Entrepreneurship Awards
Ground Rules/Expectations Obey Concentrate in Class HIMS/NAMB Training
Presentation Objectives/Expectations 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
Presentation Outline • RISK MANAGEMENT OVERVIEW • Introduction • Dimensions of Risk & Risk Management • RISK FACTORS & IMPACT ON MFIs • RISK MANAGEMENT STRATEGIES FOR MFBs • Credit Administration & Control • Fraud Prevention and Control • Auditing, Compliance and Internal Control • Training & Skills Development • CASE STUDIES IN RISK MANAGEMENT
Section A: Risk Management Perspective 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
FINANCIAL RISKS 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
TYPES OF CREDIT RISKS 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.
MARKET RISKMarket risk is the risk to a bank’s financial condition that could result from adverse movements in market price. TYPES OF MARKET RISK Interest Rate Risk Risk felt, when changes in the interest rate structure put pressure on the net interest margin of the Bank. Liquidity Risk Risk arising due to the potential for liabilities to drain from the Bank at a faster rate than assets.
TYPES OF MARKET RISK (continued) FOREX RISK This risk can be classified into three types. Transaction Riskis observed when movements in price of a currency upwards or downwards, result in a loss on a particular transaction. Translation Riskarises 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.
NON-FINANCIAL RISKS • 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
Basic Concepts in CRM 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 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
Why Loan Default Rates are High 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
The Goal of Credit Risk Management 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.
Tools for Management Of 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.
TOOLS OF CREDIT RISK MANAGEMENT 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.
Types of Credit Facilities • 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
Loan Purposes • 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
Loan Repayment • Secondary Source How will the loan repaid? • Primary Source • Will depend on the loan purpose
CREDIT ANALYSIS ‘The Process of determining a borrower’s ability to make timely repayments of a loan’
The Five “C”s of Credit Analysis What is the Purpose of the Loan? Who is the Borrower? What are the Risks & Rewards? What are the Repayment Sources?
Cash A/R A/P Inventory Cash Conversion Cycle (DSO) + (DSI) - (DPO) Days Sales Outstanding (Receivables Turnover) = (Receivables $)/ (Annualized Revenue $) * 365 Days of Supply Inventory (Inventory Turnover) = (Inventory $)/ (Annualized COGS $) * 365 Days Payables Outstanding (Payables Turnover) = (Payables $)/ (Annualized Mat’l Cost $) * 365
Fraud Prevention and control FELIX EMENIKE EJINWA JULY 2011
DEFINITION OF FRAUD - 1 Felix Emenike Ejinwa • 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.”
DEFINITION OF FRAUD Fraud can be defined as an intentional misrepresentation of facts for the purpose of obtaining personal gain. The above definition exposes three key elements that must exist before it is concluded that a fraud has occurred. • Intent • Misrepresentation of fact • Personal Gain
WHY DO FRAUD OCCUR? Some people commit fraud as a result of greed. However, there are three key reasons why fraud occur:
WHY DO FRAUD OCCUR? OPPORTUNITY This is the ability to commit fraud, created by weak internal controls, poor supervision, abuse of position and authority. Failure to establish adequate procedure to detect fraud also creates opportunity
WHO IS INVOLVED WITH CONTROLS? YOU YOU YOU Felix Emenike Ejinwa
WHY DO FRAUD OCCUR? PRESSURE/MOTIVE Pressure can include anything including unpaid bills, expensive tastes, peer pressure, addition problem e.t.c.
WHY DO FRAUD OCCUR? • RATIONALISATION This involves a person rationalizing his/her action to commit fraud i.e. fraud is justified to save a family member from dying, intends to pay back, no help is available from outside.
TYPES OF FRAUD IN BANKS 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.
FORMS OF INTERNAL FRAUD Cash Theft Stealing of cash from the till or vault, thereby creating a shortage in the books/record Suppression of customer’s deposit Cash 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 loans The supposed borrower is the bank’s employee or an accomplice Forged Documents Forgery of documents to conceal another theft or fraud
FORMS OF INTERNAL FRAUD - Contd • Fraudulent debits into accounts Unauthorized postings into customers’ or internal accounts • Expense ‘Padding’ Inflating prices of items to be purchased or under-delivery of stock • Cheque suppression Inward cheques are not debited to customer’s account within the specified clearing days • Electronic Card Frauds Fraudulent request to issue electronic card on customer’s accounts or deliberate linking a customer’s account to another customer’s account.
FORMS OF EXTERNAL FRAUD • Stolen cheques Cheque leaves are stolen and customer’s signature forged • Forged/Altered cheques • Deposit of fake Currencies • Issuance of Dud cheques Cheque drawn on unfunded accounts • Fraudulent loans • Card Frauds
EFFECTS OF FRAUD • Reduced Profit • Damage to Reputation • Reduced customer’s confidence • Low Morale among employees • Cost of Investigation
FRAUD DETECTION The key to detecting fraud is understanding the symptoms. 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
FRAUD DETECTION contd • 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
FRAUD DETECTION contd • 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
FRAUD DETECTION contd • Others • Unexplained difference in account reconciliation • Improper recording of transactions • Missing documents • Duplication • Unsupported or unauthorised documents
FRAUD PREVENTION • 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.
FRAUD PREVENTION contd 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).