risk management in microfinance banks
DESCRIPTION
Risk Management in Microfinance Banks. Rogers A. I. Nwoke MD/CEO, HASAL MFB. Presentation at the 6 th CBN Annual Microfinance Conference & Entrepreneurship Awards. Ground Rules/Expectations. Obey. Concentrate in Class. Presentation Objectives/Expectations. - PowerPoint PPT PresentationTRANSCRIPT
HIMS
Rogers A. I. NwokeMD/CEO, HASAL MFB
Presentation at the 6th CBN Annual Microfinance Conference & Entrepreneurship Awards
©HASAL INSTITUTE FOR MICROFINANCE STUDIESHIMS/NAMB Training 2
Concentrate in Class
Obey
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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
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A. RISK MANAGEMENT OVERVIEW Introduction Dimensions of Risk & Risk Management
B. RISK FACTORS & IMPACT ON MFIs
C. RISK MANAGEMENT STRATEGIES FOR MFBs‣ Credit Administration & Control‣ Fraud Prevention and Control‣ Auditing, Compliance and Internal Control‣ Training & Skills Development
D. CASE STUDIES IN RISK MANAGEMENT
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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
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©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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
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Transaction RiskRisk relating to specific trade transactions, sectors or groups.
Portfolio RiskRisk 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.
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TYPES OF MARKET RISK
Interest Rate RiskRisk felt, when changes in the interest rate structure put pressure on the net interest margin of the Bank. Liquidity RiskRisk arising due to the potential for liabilities to drain from the Bank at a faster rate than assets.
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FOREX RISKThis risk can be classified into three types.
Transaction Risk is observed when movements in price of a currency upwards or downwards, result in a loss on a particular transaction.Translation Risk arises 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.
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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
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Credit riskLoss 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
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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
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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.
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⇛ 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.
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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.
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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
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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
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How will the loan repaid? Primary Source
◦ Will depend on the loan purpose
▶Secondary Source
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Who is the
Borrower?
What is the
Purpose of the Loan?
What are the
Repayment Sources?
What are the Risks
& Rewards
?
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©HASAL INSTITUTE FOR MICROFINANCE STUDIES
Cash Conversion Cycle
Cash
Inventory
A/PA/R
Days Sales Outstanding (Receivables Turnover) =
(Receivables $)/(Annualized Revenue $) * 365
Days Payables Outstanding(Payables Turnover) =
(Payables $)/(Annualized Mat’l Cost $) * 365
Days of Supply Inventory (Inventory Turnover) =
(Inventory $)/(Annualized COGS $) * 365
(DSO) (DSI) (DPO)+ -
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FELIX EMENIKE EJINWA
JULY 2011
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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.”
7/23/2011Page 29Felix Emenike Ejinwa
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Fraud can be defined as an intentional Fraud can be defined as an intentional misrepresentation of facts for the misrepresentation of facts for the purpose of obtaining personal gain. purpose of obtaining personal gain.
The above definition exposes three The above definition exposes three key elements that must exist before key elements that must exist before it is concluded that a fraud has it is concluded that a fraud has occurred. occurred.
IntentIntent Misrepresentation of fact Misrepresentation of fact Personal GainPersonal Gain
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Some people commit fraud as Some people commit fraud as a result of greed. However, a result of greed. However, there are three key reasons there are three key reasons why fraud occurwhy fraud occur::
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OPPORTUNITY OPPORTUNITY
This is the ability to commit fraud, This is the ability to commit fraud, created by weak internal controls, poor created by weak internal controls, poor supervision, abuse of position and supervision, abuse of position and authority. authority.
Failure to establish adequate procedure Failure to establish adequate procedure to detect fraud also creates opportunityto detect fraud also creates opportunity
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7/23/2011Page 34Felix Emenike Ejinwa
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WHO IS INVOLVED WITH CONTROLS?WHO IS INVOLVED WITH CONTROLS?
YOU
YOUYOU
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PRESSURE/MOTIVEPRESSURE/MOTIVE
Pressure can include anything Pressure can include anything including unpaid bills, expensive including unpaid bills, expensive tastes, peer pressure, addition tastes, peer pressure, addition problem e.t.cproblem e.t.c. .
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7/23/2011Page 37Felix Emenike Ejinwa
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RATIONALISATIONRATIONALISATION
This involves a person This involves a person rationalizing his/her action to rationalizing his/her action to commit fraud i.e. fraud is commit fraud i.e. fraud is justified to save a family justified to save a family member from dying, intends to member from dying, intends to pay back, no help is available pay back, no help is available from outside. from outside.
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7/23/2011Page 39Felix Emenike Ejinwa
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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.
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Cash TheftStealing of cash from the till or vault, thereby
creating a shortage in the books/record
Suppression of customer’s depositCash 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 loansThe supposed borrower is the bank’s employee or
an accompliceForged Documents Forgery of documents to conceal another theft or
fraud
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Fraudulent debits into accountsUnauthorized postings into customers’ or
internal accounts Expense ‘Padding’Inflating prices of items to be purchased or under-
delivery of stock Cheque suppressionInward cheques are not debited to customer’s
account within the specified clearing days Electronic Card FraudsFraudulent request to issue electronic card on
customer’s accounts or deliberate linking a customer’s account to another customer’s account.
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Stolen chequesCheque leaves are stolen and customer’s signature
forged Forged/Altered cheques Deposit of fake Currencies Issuance of Dud chequesCheque drawn on unfunded accounts Fraudulent loans Card Frauds
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Reduced Profit
Damage to Reputation
Reduced customer’s confidence
Low Morale among employees
Cost of Investigation
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The key to detecting fraud is understanding thesymptoms. 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
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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
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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
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Others
Unexplained difference in account reconciliation Improper recording of transactions Missing documents Duplication Unsupported or unauthorised documents
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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.
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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).
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TRAITS SHARED BY MOST FRAUDSTERS
Male Intelligent (challenged by “secure” systems, bored with the job
routine) Egotistical (scornful of "obvious" control flaws, "dumb" managers,
etc.) Inquisitive (tempted by the discovery of a computer vulnerability,
for example) A risk taker (willing to bend the rules, take chances) A rule breaker (takes short cuts, self-justifies infractions of law,
rules, etc.) A hard worker (first to arrive in the morning, last to leave at night,
takes few vacations) Under stress (suffering from a personal crisis, such as a financial
problem, bad marriage, etc.) Greedy or has a genuine financial need (illness, drugs,
gambling, etc.) Disgruntled at work or a complainer
(may try to "get even", or take what he/she "really deserves") A big spender (expensive hobbies, living beyond means)
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The Don’ts: Don’t take anything for granted. Don’t volunteer confidential information over the
telephone/telex/fax unless you know and trust those who are inquiring.
Don’t allow customers to pressure you into making impulsive decisions.
Don’t give value against uncleared payment items. Don’t accept third-party cheques from new customers without
a senior manager’s authorization. Don’t cash cheques for strangers. Don’t transfer funds without first obtaining proper
authorizations. Don’t discuss internal operations or systems with outsiders. Don’t write to suspicious individuals on company stationery. Don’t be afraid to contact the police if you have suspicions
about certain customers and their respective business dealings.
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Be Cautious Always resist promises of inordinately high returns and
guarantees of endless supplies of funding. Nothing ever comes for free. Think twice when you are presented with confusing
business proposals or when potential business partners supply vague answers.
And should you ever be requested to provide letters printed on your company letterhead, outlining potential new business relationships, always decline.
Remember, you are the only one who can save yourself from fraud.
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The average person is totally unaware of the magnitude of fraudulent activity that occurs on an ongoing basis. Having gone through this workshop to this point, you should understand its far-reaching effects and be able to better identify examples of this crime.
It cannot be emphasized strongly enough that unfamiliar companies need to be investigated thoroughly if you are contemplating a business association with them.
Walk away from questionable activities: never be afraid or too embarrassed to immediately report them to your local police departments. These authorities are there to help you to deter new and repeat offenders. They receive regular updates on successful and unsuccessful frauds, and will often recognize a particular fraudster’s method of operation.
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Anticipate criminal activityIf you become suspicious of a recently established business relationship,terminate it. Companies can appear straight-forward at the outset. Once
theyhave earned your trust, they may subsequently initiate criminal activity.
Similarly, terminate long-term business dealings with associate companies if management, for some reason, begins to act abnormally. Take nothing for granted.
Also, be cautious of those approaching you professing to represent legitimatebanks. If they offer to deal with your company and you are unfamiliar with
theirfinancial institutions, refer to such publications as the Bankers’ Almanac, etc
which can be found at local library. They list all the major international banks, their histories,ownership status, and assets and liabilities.
Above all, remember, if a deal looks too good to be true, it very likely is – and usually involves fraud.
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Training ◦ Management Associates◦ Operations/Control staff◦ Marketing/RMs◦ Credit Officers◦ Management
Sharing experience with/of other Financial Institutions
Learning from experiences Selectively fighting back (but …. CARE?)
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Learn from our mistakes (and from the mistakes of others) Run training courses – Fraud Awareness for Bankers in all
jobs. Maintain specialist investigation teams Maintain a Network of Contacts (“I know a person..”) Ensure that bankers remain professionally skeptical and are
never too embarrassed to say “I do not understand” Deal quickly, thoroughly and efficiently with all cases,
hitting the Fraudsters where it hurts most (in their wallets) Design fraud out of a systems and processes.
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Accounting and Procedure Manual
Local Policies and Procedures
Credit Manuals
System Manual
Desk Manuals
What Are The Tools Available To Perform The Control Functions?
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Operating Losses
Reporting Errors
System/Dev. Fiascos
Corporate Embarrassment
Fraud
WHAT HAPPENS IF WE HAVE POOR CONTROLS?
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The compliance The compliance departmentdepartment
The businessThe business
The Regulators & FraudstersThe Regulators & Fraudsters
Business and Compliance must work together to avoid Business and Compliance must work together to avoid regulatory & reputation sanctions and Fraudsregulatory & reputation sanctions and Frauds
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Internal Audit & Control Function
Internal audit being an integral part of banks internal control system functions as an independent, objective assurance and consulting activity designed to add value and improve the banks operations.
It is a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and corporate governance processes.
Internal audit reviews and ensures integrity of information, compliance with policies and regulations, safeguarding of assets and efficient use of resources.
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Independence of Internal Audit Function & Ethics
To function as the main machinery for the maintenance of internal controls, the auditor must be independent and given unrestricted access to information and records.
He should report directly to the Board Audit Committee and also administratively to the MD/CEO as well as coordinate audit activities with external auditors and examiners (CBN/NDIC).
High premium is placed on effective staffing of the internal audit department with highly skilled, competent, and independent people of high integrity.
The internal auditor is not expected to perform operational duties and his performance should not be based on profit or revenue goals.
His independence therefore facilitates his functional role for safeguarding assets, ensure compliance with internal policies and procedures as well as laws and regulations.
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Summary & Conclusions
•The role of independent, competent and qualified auditors facilitates the internal control function which are vital to the corporate governance process in order to achieve the objective of safeguarding stakeholders’ interests.
• In particular, internal auditors should facilitate the control function to provide an independent check and assurance on the information received from management on the operations and performance of the bank.
• This goes a long way in determining the long-term soundness of the bank to sustain the going concern.
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Questions & Questions & IssuesIssues
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