Managing Microfinance Risks: Some Observations and Suggestions

Risk is an integral part of financial intermediation. Hence, risk management must be at the heart of finance. However, it is disturbing to note that systematic risk management is still not as widespread as it should be in the microfinance industry. Except for a few flagship microfinance institutions (MFIs), which constitute the core of the industry, most MFIs do not pay adequate attention to systematic risk management. The microfinance industry has grown rapidly during the last decade in breadth, depth, and scope of outreach. The rapid growth seems to continue, given the massive unserved and underserved market. The growth of the industry has changed the risk profile of MFIs. Yet many MFIs seem to continue to seek growth without much attention to attendant risks. Surprisingly, many MFIs appear to neglect even the basic credit risk management which helped MFIs achieve high growth rates historically. The growing interest of many MFIs in agricultural microfinance must be seen in the broader context of risk management in the industry. Financing agriculture is more risky than financing trade or industry; it is also more risky than financing nonagricultural microenterprises. However, MFIs interested in agricultural microfinance should be more concerned about their internal structures and capabilities rather than the widely discussed, and often cited, pervasive risks in agriculture and their ramifications for the MFIs’ pursuit of growth in agricultural microfinance. MFIs should recognize the inherent risks in agriculture. However, if they build their institutional capacity to effectively deal with risks generally associated with financial services for poor and low-income households, their prospects for success in agricultural microfinance would certainly be much brighter. In addition, no amount of sophisticated and modern technical tools and analysis can help achieve effective risk management in respect of nonagricultural or agricultural microfinance if risk management is not embedded into the institutional culture and its value is not shared by all employees. Achieving this goal remains one of the most challenging tasks in risk management which MFIs need to address. To help in this effort, we need to bring into the discussion—now dominated largely by issues related to introducing sophisticated systems and technical tools of risk management—the institutional cultural issues and issues related to cognitive biases in executive decision-making behavior.