Risk Management Guidelines for Microfinance Institutions

Ethiopia

(amended through 2010)

1. General Background

1.1 Introduction
This section emphasizes risk management as crucial to successful microfinance.

1.2 Objectives
This document provides a risk management framework for all microfinance institutions operating in Ethiopia, setting minimum risk identification, measurement, monitoring and control system and enhancing risk management practice. The guidelines are in line with internationally accepted risk management principles and best practices. Microfinance institutions are encouraged to become risk focused, basing supervision and internal audits on risk management.

1.3 Risk Management Programs
The National Bank requires each microfinance institution to prepare a comprehensive risk management program addressing:
– Strategic Risk
– Credit Risk
– Liquidity Risk
– Interest Rate Risk
– Operational Risk

1.4 Risk Management Process
Risk management optimizes risk-reward trade-off. Risk management consists of 4 key processes:
– Risk Identification
– Risk Measurement
Risks should be measured in terms of size, duration, and probability of adverse occurences
– Risk Control
Risks may be controlled or minimized by avoiding/placing limits on activities/risks, mitigating risks, and/or offsetting risks.
– Risk Monitoring

1.5 Basic Elements of Risk Management Framework
The key elements to a sound risk management system include:
– Active board and senior management oversight
– Adequate policies, procedures, and limits
– Adequate risk measurement, monitoring, and management information systems
– Comprehensive internal controls
A risk management committee or risk manager should be assigned to evaluate and determine level of risk.
Risks should be considered in relation to each other.
Contingency planning is also crucial to risk management.
Microfinance institutions must submit their risk management systems and updates within three months from the effective date for review by the National Bank.

2. Strategic Risk Management Guidelines
Strategic Risk refers to the potential negative impact on an institution’s earnings and capital due to decisions taken by the organization or the manner in which business strategies are executed. Strategic Risk Management requires the board and senior management to play a role. Policies and procedures, as well as methods for measurement, monitoring, and control should be created. An internal control system and a flexible strategic planning process should exist.

3. Credit Risk Management Guidelines
Credit Risk is the risk to earnings or capital due to a borrower’s late or non-payment of loan obligation. Effective approaches to credit risk management include active oversight by board and senior management, borrower screening, careful loan structuring, clear collection procedures, and good portfolio reporting. The board should be responsible for reviewing and approving credit risk strategy and policies, while management is responsible for the execution of the strategy and policies. The board is responsible for forming a credit risk management committee, whose purpose is to address issues relating to credit policy and procedures. These policies and procedures should encompass clear guidelines regarding borrower analysis and approval, credit limits and diversification, and risk mitigation. Risk measurement, monitoring, and control should be established, keeping accurate records, stress testing, managing problem credits, maintaining a sound information system, and continually gauging and assessing risk.

4. Liquidity Risk Management Guidelines
Liquidity Risk is the risk of being unable to meet commitments, repayments, and withdrawals at the correct time and place. Liquidity Risk Management is overseen by the board and senior management, as well as an asset liability committee, which may be formed to monitor and address asset growth and liabilities. These parties are responsible for ensuring that appropriate policies and procedures are established, as well as methods for measurement, monitoring, and control.

5. Interest Rate Risk Management Guidelines
Interest Rate Risk is the exposure of institution’s financial conditions to adverse movements in interest rates. Changes in interest rates affect earnings by changing net interest income, other interest-sensitive income, operating expenses, and future cash flows. The board and senior management are responsible for interest rate policies and procedures and methods for measurement, monitoring, and control.

6. Operational Risk Management Guidelines
Operational Risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events or unforeseen catastrophes. Again, operational risk policies and procedures and methods for measurement, monitoring, and control are instituted by the board and senior management.

7. Mapping of Inherent Risk onto Functional Risk Management
The risks described above in this document should be mapped into functional areas derived from key business activities. The type and level of risk for each of these activities should be identified and outlined.