Risk management for microfinance institutions

Abstract

Abstract The Microfinance industry today is growing rapidly. Several large financial institutions and aid agencies are realizing the benefits of MFIs in reducing poverty. MFIs no longer face the crunch of capital. What is required today is sound management of such MFIs to make sure they achieve their objectives, both social and financial. As the MFI industry matures, many MFIs no longer work as NGOs and non profit organizations. MFIs are ’transforming’ into regular financial institutions. In such a scenario, risk management becomes very important. This work is a small step in identifying sound risk management practices for MFI. To accomplish this objective, we have taken Ujjivan, a Bangalore based MFI as a case study, and tried to identify the sources of risks and the methods to mitigate the same. While there is sufficient literature for risk management in regular financial institutions such as banks, most of these are not applicable to MFIs. The greatest source of risk to an MFI is operational risk and strategic risks (competitive and political). Hence, this report focuses mainly on these aspects and uses Ujjivan to identify such risks, and suggest solutions, that are more general and can be applied to most MFIs. Managing operational risks involves making decisions on the organization structure, handling employee fraud and attrition, monitoring and designing incentive schemes for employees, audit of operational policies and procedures etc. Political risk is the risk of political events/directives affecting operations. In this study, we have tried to see the impact of political risk on MFIs, and have quantified the same. The recent events in AP show the level of impact the government can have on MFI. This study reveals the reasons for the same, and strategies to minimize the impact of these events on MFI operations. As the MFI industry matures, competition will soon play a very important role in the operational policies of MFI. In this study, we have tried to see how competition can affect MFI, and what could be the potential impact of increased competition on MFI. Strategies have also been enumerated to tackle the same. While this study uses Ujjivan as an example, the suggestions made are very much applicable to other Urban MFIs following the Grameen model of Microfinance.