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Risk management lessons in Micro Finance from around the world

Indian Economy & Policy | NA



The micro-finance universe in India is expanding rapidly - both in terms of numbers and volumes of funding. It has penetrated the under-served and unserved sections of the economy and its socio-economic contribution is quite apparent. Regulators have begun to sit up and take notice of this growing source of development and have begun supporting it by putting in place robust and transparent policy frameworks.

 

There is another interesting facet of the micro-finance industry in India today – from a largely ‘not-for-profit’ sector, it has evolved into a sector with modest returns which, when cumulated over the large base of prospects, makes the sector completely sustainable. This opportunity has attracted various multi-national lenders, non-banking finance companies and private equity firms. In addition to people skills, technology has enabled companies to bringing down operational costs, enabling greater customisation and enhancing penetration. And, going forward too, lenders in the MFI space will have to find the right blend of technology and human interface,while providing financial solutions to their clients. Effectively, technology has contributedto putting in place systems and processes that maximise the target borrowers and minimise the risk.

 

Nevertheless, as with any other business involving lending, risks do persist. In fact, the very source of growth – the rise in the number of clients – theoretically raises the risk. The RBI raising the cap on indebtedness to a borrower from INR 50,000 to INR 100,000 in 2015 also triggered the potential for greater risk. Most of all, the very premise of micro-finance - serving vulnerable segments of society - increase the underlying risk of lending. Ironically, all these factors are the very reasons why the micro-finance segment is considered a great opportunity. So, in a nutshell, while risk is an integral part of micro-finance lending, adopting tried and tested best practices to minimise or at least gauge the risks involved, enable lenders to take calculated risks.

 

According to a report by EY,‘Evolving landscape of microfinance institutions in India’ – (July 2016), over the years, microfinance companies have devised innovative risk management strategies such as group lending, turning to innovative ways to garner funds, etc. These organisations have forged linkages with informal community savings groups to fill credit gaps left by formal financing bodies, raised funds from large corporations, tapped into crowd funding, etc. Technology, such as the use of mobile devices, biometrics, personal digital assistants, etc., has also been used to transform the microfinance space by helping to reduce costs, improve efficiency and increase outreach. Combinations of solutions have been used in various situations, depending on the unique exigencies. However, based on successfully implemented MFI models from around the world, some of the leading best practices for flexible risk management systems that have emerged include:

 

Decentralization: Developing a culture, which encourages internal controls that delegate adequate authority to loan officers, enables them to be responsive to client needs. This requires establishing a culture of trust between the management, financial intermediaries and borrowers. If instituted, it helps reduce cost of internal controls.

 

Effective support system: In addition to an effective support system of information technology and sound MIS, risk-monitoring activities must also be supported by systems that provide senior managers and directors with timely and accurate reports on the financial condition, operating performance and risk exposure of the institution. These risk monitoring and MIS activities should be consistent with MFI’s operations.

 

Culture of training: To build a competent and loyal employee base, a culture of providing regular training becomes crucial. It improves efficiency and helps reduce costs.

 

Openness and client centred approach: A client-centred approach helps design products according to the needs of the customer. This approach facilitates the management of financial/ cash flow risks more effectively as resources can be allocated on components that help maximize profits.


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