Microfinance institutions (MFIs) face increasing challenges in today’s global economy. Growth rate worldwide for microfinance institutions is frenetic, as MFIs try to satisfy the demand for financial services to economically challenged clientele while keeping an eye on carving out a reasonable market share amidst stiff competition. Add to that the credit risk inherently involved in microfinancing as well as the currency risk in developing economies, and it becomes clear that portfolio analysis and risk management strategies are essential to the health of any MFI.
A recent study entitled “Portfolio Analysis and Risk Management Practices of MFIs: A Global Study”, authored by Ashirul Amin and Robert Mora and produced by Trilinc Global, LLC provides useful insight regarding the standard practices of MFIs in matters of portfolio analysis and risk management. Participating in the study were 67 MFIs, ranging in size from small to mid-sized. Respondents represent non-profits, non-bank financial institutions, and co-ops. The purpose of the study is to help identify effective risk management practices and innovations.
One finding of the study is that as growth occurs, portfolio risk management strategies often fail to keep pace in terms of handling diversity and depth of analysis required to reduce risk. While almost all MFIs surveyed use some sort of computerized accounting system, fewer than half have a computerized risk management system in place.
Financial Reporting Practices
Most surveyed respondents report generating P&L statements, balance sheets, and cash flow statements on a monthly basis, with an annual audited version for review purposes. Most also generate financial ratios either monthly or quarterly, with a view to obtaining a snapshot of the health of the portfolio.
Portfolio Management Systems
Twenty-six percent of responders outsource their portfolio analysis. This statistic shows that there is much room for software-as-a-service providers to step in to better serve the market. The most attractive offerings in the way of such software include customizable options to more specifically meet an individual MFI’s needs.
Clients who delay switching from manual systems made in-house face the problem of continually adding to their existing system in an attempt to service an ever-increasingly diversified portfolio, making it even harder to migrate to a better, more agile system down the road.
Data Collection and Reporting of Delinquencies
Ideally, financial data can be entered into Portfolio Management systems quickly and locally, increasing analytical potential in a profound way. Reporting delinquencies promptly and accurately also helps with the management of cash flow and the maintenance of a healthy portfolio. Reducing lag time in reporting these important matters has been shown to increase understanding of all components of the portfolio and enable the more accurate forecasting of various metrics. And there is a direct correlation between accurate forecasting and a healthy portfolio.
Decreasing Risk Management Concerns
Regarding the importance of risk management strategies, a 2012 report by Deutsch Bank reveals that microfinance is an industry caught between crisis and advancement. As global economic crisis continues to profoundly affect microfinance, it has become apparent that many microfinance institutions lack adequate risk management capabilities, often subordinating prudent lending to fast growth and short-term profits.
This short-sighted approach not only weakens the long-term viability of an microfinance institution, but also strays widely from the original social goals of the microfinance institution model. So, is the answer simply turning back to the less commercialized origins of microfinance? According to industry observers, the answer is not that simple.
Important steps to reduce risk consist of a multi-pronged approach. First and foremost, microfinance institutions must put client needs back in the focus of all operations. Of necessity, this includes a careful analysis of what clients need, how they live, and what they demand. Also included in this most essential step is an evaluation of how products tailored to client needs impact the society in which they live. This heightened sense of social responsibility will likely be the saving grace for successful microfinance institution operations in the 21st century.
Secondly, to meet the challenge of this more socially aware climate, microfinance institutions must ensure better training of staff, thereby increasing the quality of borrower selection and improving the adequacy of repayment incentives. While hiring and training of superior staff involves additional costs, it is easy to see that this important step reduces risk by a considerable amount in the long-term, as it contributes to better social performance and less volatile financial results.
Shoring up risk management strategies while maintaining focus on social objectives creates a challenge for modern microfinance institutions. However, taking the necessary steps to create quality portfolio analytics and risk management systems will ensure the prosperity of microfinance institutions and their clients for the foreseeable future.
In summation, these studies indicate a need for accurate information, conveyed quickly into an agile portfolio management system, as well as development of a socially perceptive risk management system to ensure the health of an microfinance institution’s portfolio at every stage.