Risk assessment challenge
End of July Bank of Russia approved the second base standard of risk management for the micro-finance market. A number of market players has already expressed discouraging forecast: in their opinion this kind if standard will force almost half of smaller MFOs’ to leave the market because of excessive expenditures required to comply with the standard. Will the standard in and of itself become the regulating risk – lethal for a number of MFOs or all in all will be none the protection from bigger risks?
Despite the crisis, micro-financing market even now looks like “the land of vast possibilities for all and everybody”. Bank of Russia has reckoned that for 2016 total amount of loans issued by MFOs increased by 39.4%, and the number of signed loan agreements increased by 67.9% in comparison to the previous year.
However these great possibilities are not for all rather than market leaders. During the year of 2016 we observed dramatic escalation of the market, indebtedness share on the principal amount of a loan issued under micro-financing plan by 100 major MFOs increased from 69.7% up to 78.7%. And eventually the major players of the market to a great degree fueled the growth of this segment. The share of smaller MFOs in increasing number of new borrowers and loan agreements rather demure than it looks like on the face of total numbers of statistics. Smaller MFOs either withdraws from market stop developing. It’s difficult and expensive for small and medium size companies to streamline business processes in order to meat the requirements of new norms and regulations.
Changes in the market rules that are taking place in recent years became one of the factors forcing small MFIs out the market. Smaller companies find it difficult and expensive to streamline business processes to meet requirements of the new rules and regulations. Therefore, the basic standard for risk management raises justified fears of ordinary market players — how much will it cost to implement it?
The standard obliges microfinance organizations to create a system for managing major risks — credit, operational, legal, liquidity risks.
- to develop a Policy Statement on risk management with a description of all procedures and persons responsible;
- employ at least one full-time specialist in risk management. At the same time, MFCs, as well as the MCCs with arrears of 1 billion Rubles and more for the principal amount of a loan are obliged to create a separate risk management unit. The risk management units should be independent of other units and report directly to the company’s management;
- prepare the risk register (description of risk, its sources, consequences, probability of implementation, risk management actions and procedures, etc.), passport of each risk, risk map;
- provide ongoing monitoring of these risks and carry out measures to reduce them — for example, if necessary, hedge the risk, insure or reserve funds for it;
- review these documents in order to update them and send reports to the governing bodies of MFIs at least once a year.
For small MFIs with a staff of up to ten people, the costs, at first glance, look «incompatible with life.» the average salary of the risk manager In the capital city is 150-200 thousand Rubles a month, in regions the specialist of this profile will be cheaper, but it is more difficult to find qualified personnel. Additional costs under this scenario can be at least about 2 million Rubles per year.
Indeed, a full-fledged risk management can become a costly affair, especially if the company did not initially invest in this direction. In addition to staff costs, it may be necessary to purchase and implement scoring technologies in the Bureau of Credit Histories (BCH) or a specialized IT company and automation of some other business processes. Additional costs according to this scenario can easily reach the minimum amount of 2 million Rubles per year.
The basic standard approved by the Bank of Russia are meant to be basic since it sets out eventually the most general parameters, the details of its implementation remain at the discretion of an MFI itself.
For example, outsourcing the risk taker from outside is not the only option. The standard permits the appointment of a risk manager within the company, expanding the job description of one of the specialists already working in the company. An employee of the parent MFI may perform the functions of the risk manager in a subsidiary company or in the group of companies. Some functions may be delegated under a contract of a third-party organization — for example, a consulting firm.
A company may of course comply with the standard very formally: issue a few papers, rename the call-center operator as a risk manager and forget about the standard until compliance assessment moment.
So it is unlikely we can expect that the innovation will cause large scale closing of small MFIs. At the same time, even with minimal costs, it can bring tangible benefits, especially to small players. Such MFIs were originally built precisely as small businesses and not as a financial company, and rarely manage systemic risks.
The Russian MFI market has traditionally attracted entrepreneurs far from the financial sphere. Retail, service, IT, education section of economy were feeding microfinance sphere. Such MFIs were originally built as small businesses, not as a financial company, and are rarely managing risks on the system level.
Over the past year and a half more than 1300 MFIs, one third of market participants, have been excluded from the Register of microfinance organizations. Most of these companies had no business by the time they were removed from the Registry. Among them there were companies that were created just in case and never started work, and companies whose owners had deliberately refused to maintain microfinance activity in favor of other business lines. However, a significant share of companies stopped working precisely because they underestimated certain risks.
First of all, underestimating credit risk may result in closing of business. Excessively optimistic approaches to assessing borrowers build up portfolio that is almost impossible to collect. Credit risk requires constant reassessment due to changes in the economic situation or, for example, seasonal variations of activity in the region.
Regulatory risks underestimation may also become fatal for many companies. Small MFIs rarely monitor draft laws prior to them being passed. Therefore, many legislative restrictions that reduce the profitability of the portfolio were not feasible for MFIs. In a number of cases, this could be avoided through monitoring draft laws in advance and preparing a new business model that takes into account the possible restrictions. For example, in autumn the MFO can expect a new standard – on the operations in the financial market, and several new draft laws have already been introduced to the State Duma that restrict business of MFIs. Often monitoring and evaluation of all risks are conducted, but only in the head of the owner or director of the organization.
The experience of communicating with small MFIs shows that monitoring and evaluation of all risks are often conducted, but only in the head of the owner or director of the organization. The head also keeps plans of action in the event of a particular risk actualizing. Usually the head of the company understands the importance of these issues. It is difficult to imagine an MFI that does not manage credit risk or liquidity risk. It is the duty of any businessman to know if you can pay off the bills tomorrow.
However, such guesstimation of the risks » once in a while» and «estimation by the eye » is often failing small microfinance business. There should be a clear understanding: at what point the level of risks becomes threatening, what risk is of paramount importance now, and what will be tomorrow, what is the threat of each risk according to a 5-point assessment scale, what percentage of the profit will the company lose if the risk actualizes. In business, like in aviation, there is always the single risk that is not fatal, but the sum of several small circumstances easily resolved individually can be multiplied into a disaster.
That is why I am sure that the introduction of an obligatory basic standard will help to keep the business of small MFIs, if it is conducted with at least minimal meaning. When there are many risks, it is useful be not only an expert in them, but also to write them down on paper. Better reflect them in Policy Statement, the Register, the passport of risks and the risk map.
Chairman of the Board of Directors of MCC Vyruchai- Dengi