HIMS
Presentation at the 6th CBN Annual Microfinance Conference & Entrepreneurship Awards
Rogers A. I. Nwoke
MD/CEO, HASAL MFB
Obey
Concentrate in Class
©HASAL INSTITUTE
FOR MICROFINANCE STUDIES
HIMS/NAMB
Training
2
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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
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
A.
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B.
C.
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RISK MANAGEMENT OVERVIEW
Introduction
Dimensions of Risk & Risk Management
RISK FACTORS & IMPACT ON MFIs
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
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
What is Risk?
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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
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
Risk
Financial
Credit Risk
Portfolio
Risk
Transaction
Risk
Non-Financial
Operating
Risk
Market Risk
Liquidity
Risk
Interest
Rate Risk
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
Exchange
Risk
Political
Risk
Legal
Systemic
Human
Capital
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
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
TYPES OF MARKET RISK
Interest Rate Risk
Risk felt, when changes in the interest rate
structure put pressure on the net interest
margin of the Bank.
Liquidity Risk
Risk arising due to the potential for
liabilities to drain from the Bank at a faster
rate than assets.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
FOREX RISK
This 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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
HIMS
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
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
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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Lax credit standards for borrowers and
counterparties
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Poor loan monitoring standards
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Poor portfolio risk management
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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
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
⇛ 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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
HIMS
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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
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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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©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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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
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Bridge Loans
◦ Used to fill funding gaps pending next financing
◦ Repayment is made from permanent financing
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Project Financing
◦ Used for specific financing of capital investments
◦ Repayment is from the future cash flows of the project
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Lease Finance
◦ Used to support asset acquisition
◦ Repayment may come from the cash flows of the asset
financed
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
How will the loan repaid?

Primary Source
◦ Will depend on the loan purpose
• Asset
Conversion
• Cash Flow
Short Term
Long Term
Refinancing
Collateral
▶Secondary Source
• Loan Purchase
• Equity
• Long-Term Debt
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
• Sale
HIMS
Who is the
Borrower?
Conditions
What is the
Purpose of
the Loan?
Collateral
Security of Transaction
Capital
Wealth of Borrower
Capacity
What are
the Risks
&
Rewards?
Ability To Pay
Character
Willingness to Pay
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
What are
the
Repayment
Sources?
CASH
RAW
MATERIALS
BANK
DEBTORS
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
FINISHED
GOODS
Cash Conversion Cycle
Cash
A/R
A/P
Inventory
(DSO)
Days Sales Outstanding
(Receivables Turnover) =
(Receivables $)/
(Annualized Revenue $) * 365
+
(DSI)
Days of Supply Inventory
(Inventory Turnover) =
(Inventory $)/
(Annualized COGS $) * 365
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
-
(DPO)
Days Payables Outstanding
(Payables Turnover) =
(Payables $)/
(Annualized Mat’l Cost $) * 365
HIMS
•CREDIT ANALYSIS & APPROVAL
•
Purpose
•
A:
Amount
•
Repayment
•
Tenor
•
Collateral/Security
•LOAN DOCUMENTATION & DISBURSEMENT
•
B:
Offers Letter
•
Loan Agreements & Covenants
• Perfection of Collateral/Security
•LOAN MONITORING
C:
•CREDIT ADMINISTRATION
•LOAN RECOVERY & REMEDIAL ACTION
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
HIMS
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.”
Felix Emenike Ejinwa
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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Fraud can be defined as an intentional
misrepresentation of facts for the purpose
of obtaining personal gain.
The above definition exposes three key
elements that must exist before it is
concluded that a fraud has occurred.
 Intent
 Misrepresentation of fact
 Personal Gain
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
Some people commit fraud as a
result of greed. However, there
are three key reasons why fraud
occur:
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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OPPORTUNITY
This is the ability to commit fraud, created by
weak internal controls, poor supervision,
abuse of position and authority.
Failure to establish adequate procedure to
detect fraud also creates opportunity
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
Felix Emenike Ejinwa
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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WHO IS INVOLVED WITH CONTROLS?
YOU
YOU
Felix Emenike Ejinwa
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
YOU
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PRESSURE/MOTIVE
Pressure can include anything including
unpaid bills, expensive tastes, peer
pressure, addition problem e.t.c.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
Felix Emenike Ejinwa
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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 RATIONALISATION
This involves a person rationalizing
his/her action to commit fraud i.e.
fraud is justified to save a family
member from dying, intends to pay
back, no help is available from
outside.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
Felix Emenike Ejinwa
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
7/23/2011
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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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
Cash Theft
Stealing of cash from the till or vault, thereby
creating a shortage in the books/record
Suppression of customer’s deposit
Cash 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 loans
The supposed borrower is the bank’s employee or
an accomplice
Forged Documents
Forgery of documents to conceal another theft or
fraud
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
Fraudulent debits into accounts
Unauthorized postings into customers’ or internal
accounts
 Expense ‘Padding’
Inflating prices of items to be purchased or underdelivery of stock
 Cheque suppression
Inward cheques are not debited to customer’s account
within the specified clearing days
 Electronic Card Frauds
Fraudulent 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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©HASAL INSTITUTE FOR MICROFINANCE STUDIES
Stolen cheques
Cheque leaves are stolen and customer’s signature
forged
 Forged/Altered cheques
 Deposit of fake Currencies
 Issuance of Dud cheques
Cheque drawn on unfunded accounts
 Fraudulent loans
 Card Frauds
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©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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Reduced Profit
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Damage to Reputation
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Reduced customer’s confidence
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Low Morale among employees
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Cost of Investigation
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
The key to detecting fraud is understanding the
symptoms. 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
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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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
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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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
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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Others
Unexplained difference in account reconciliation
Improper recording of transactions
Missing documents
Duplication
Unsupported or unauthorised documents
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
Prevention of fraud is a two stage process:
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ensure that opportunities for fraud are minimised,
(fraud prevention), and
ensure that potential fraudsters believe they will be
caught, (fraud deterrence).
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
TRAITS SHARED BY MOST FRAUDSTERS
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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)
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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The Don’ts:
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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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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Be Cautious
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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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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Anticipate criminal activity
If you become suspicious of a recently established business relationship,
terminate it. Companies can appear straight-forward at the outset. Once they
have 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 legitimate
banks. If they offer to deal with your company and you are unfamiliar with their
financial 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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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Training
◦
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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?)
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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What Are The Tools Available To Perform
The Control Functions?

Accounting and Procedure Manual

Local Policies and Procedures
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Credit Manuals
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System Manual
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Desk Manuals
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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WHAT HAPPENS IF WE HAVE POOR CONTROLS?
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Operating Losses
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Reporting Errors
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System/Dev. Fiascos
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Corporate Embarrassment
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Fraud
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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The business
The compliance
department
The Regulators & Fraudsters
Business and Compliance must work together to avoid
regulatory & reputation sanctions and Frauds
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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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.
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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Questions &
Issues
©HASAL INSTITUTE FOR MICROFINANCE STUDIES
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