APPENDIX 1: Interview AMMOR’s staff en executive commission
Nombre : Función :
1) ¿Cuál es la fecha de la constitución del fondo nacional ?.
2) ¿Cuál es el tamaño del fondo nacional en pesos mexicanos?.
3) ¿Para qué tipo de proyectos AMMOR emite préstamos?.
4) ¿Quién puede pedir un préstamo?.
5) ¿Cuales son los criterios de selección ?.
6) ¿Cómo verifican si el prestamista de verdad cumple con los criterios ?.
7) ¿Qué documentos oficiales solicita AMMOR
8) ¿Exigen que el prestamista firme un contrato oficial?.
i. ¿Qué temas figuran en este contrato?.
9) ¿Cuál es el tamaño mínimo/máximo y mediano de los préstamos? . 10) ¿Sube el monto máximo con cada préstamo? .
11) ¿ Cuál es el tipo de interés mínimo/máximo/mediano?.
12) ¿Hay diferentes intereses para clientes con diferentes capacidades de pago?.
13) ¿Existe algún reconocimiento , con respecto al interés para los clientes que hayan cumplido a término un préstamo anterior?.
14) ¿Cuál es el plazo mínimo/máximo/mediano?.
i. ¿De qué depende el plazo?.
15) ¿Cuántos préstamos han sido emitidos durante el período 01-01-2000 / 01-01-2004?.
16) ¿Cómo observan si el prestamista es capáz de devolver el préstamo ?.
17) ¿Cuándo se considera un préstamo con demora?.
20) ¿Qué medidas toman Uds cuando un préstamo está con demora ?.
¿Cuál porcentaje de clientes vuelve a rembolsar el monto después de cada medida?.
21) ¿Cómo arreglan los pagos en caso de un préstamo en demora?.
22) ¿Qué porcentaje de los préstamos nunca fue reembolsado?.
23) ¿Qué tipo de garantía exigen al prestamista? .
APPENDIX 2: Interview Regional Representatives 24-07-2004
Nombre : Organización : Función :
1) ¿Para qué tipo de proyectos AMMOR emite préstamos?.
2) ¿Cuáles son los criterios se selección ?.
3) ¿Cómo verifica AMMOR si Uds. de verdad cumplen con los criterios ?.
4) ¿Qué documentos oficiales les solicita AMMOR?.
5) ¿Exigen que Uds firmen un contrato oficial?.
¿Qué temas figuran en este contrato?.
6) ¿Cuál es el tamaño mínimo/máximo y mediano de los préstamos? . 7) ¿ Se incrementa el monto máximo con cada préstamo ?.
8) ¿ Cuál es el tipo de interés mínimo/máximo/mediano?.
9) ¿ Hay un interés más bajo para clientes que hayan cumplido a término un préstamo anterior?.
10) ¿ Cuál es el plazo mínimo/máximo/mediano?.
¿De qué depende el plazo?.
11) ¿Tienen Uds acceso a otras fuentes de financiamiento para sus proyectos?.
12) ¿Cuántos préstamos han pedido en el período 01-01-2000 / 01-01-2004?.
13) ¿Su organizacion ya habia pedido un préstamo antes de 01-01-2000?
14) ¿Cómo evalua AMMOR si Uds. son capaces de devolver el préstamo ?.
15) ¿Cuándo considera AMMOR que un préstamo está con demora?.
16) ¿Cuántos de sus préstamos han estado con demora?.
¿Por cuánto tiempo ?.
17) ¿ Cuáles han sido las medidas tomadas por AMMOR al existir préstamos con demora ?.
APPENDIX 3: Interview & Questionnaire 12-10-2004
Nombre : Organización : Función :
Importante :¡ Las personas que ya han completado las primeras 20 preguntas pueden pasar directamente a la segunda parte !.
1) ¿Para qué tipo de proyectos AMMOR emite préstamos?.
2) ¿Cuáles son los criterios de selección ?.
3) ¿Cómo verifica AMMOR si Uds. de verdad cumplen con los criterios ?.
4) ¿Qué documentos oficiales les solicita AMMOR?.
5) ¿Exigen que Uds firmen un contrato oficial?.
¿Qué temas figuran en este contrato?.
6) ¿Cuál es el tamaño mínimo/máximo y mediano de los préstamos?
7) ¿ Se incrementa el monto máximo con cada préstamo ?.
8) ¿ Cuál es el tipo de interés mínimo/máximo/mediano?.
9) ¿ Hay un interés más bajo para clientes que hayan cumplido a término un préstamo anterior?.
10) ¿ Cuál es el plazo mínimo/máximo/mediano?.
¿De qué depende el plazo?.
11) ¿Tienen Uds acceso a otras fuentes de financiamiento para sus proyectos?.
12) ¿Cuántos préstamos han pedido en el período 01-01-2000 / 01-01-2004?
13) ¿Su organizacion ya habia pedido un préstamo antes de 01-01-2000?
14) ¿Cómo evalua AMMOR si Uds. son capaces de devolver el préstamo ?.
15) ¿Cuándo considera AMMOR que un préstamo está con demora?.
16) ¿Cuántos de sus préstamos han estado con demora?.
¿Por cuánto tiempo ?.
17) ¿ Cuáles han sido las medidas tomadas por AMMOR al existir préstamos con demora ?.
18) ¿Cómo eran renegociados los pagos en caso de un préstamo con demora?.
19) ¿Cuál fue el motivo de la morosidad?.
20) ¿Qué tipo de garantía exige AMMOR?.
Parte dos
1) ¿Cuántos proyectos son financiados 100% con un préstamo de alguna otra fuente de financimiento que el fondo nacional AMMOR en el período 01-01-2000 / 01-01-2004?.
2) Cuántos proyectos son financiados 100% con un préstamo del fondo nacional de AMMOR en el período 01-01-2000 / 01-01-2004?.
3) ¿Cuántos proyectos son financiados 100% con una combinacion de préstamos de el fondo de AMMOR y otras fuentes de financimiento en el período 01-01-2000 / 01-01-2004?.
4) ¿De los siguente tres criterios de selección, cuál es el más importante?.
A ¿Los objetivos como figuran en la quinta claúsula del convenio ?.
B ¿Los requisitos que figuran en el reglamento interno ?.
C ¿La presentación de un plan de negocio ?.
5) ¿Cuáles son los temas obligatorios del plan de negocio?.
6) ¿Cuáles son los temas obligatorios de los informes periódicos?.
7) ¿Cuál es intervalo entre dos informes periódicos?.
8) ¿Quién es responsable por el contenido de los informes periódicos?.
9) ¿Ud. se siente responsable por el resultado (éxito/ fracaso) de un proyecto de los grupos de trabajo locales?.
10) ¿Ud. será afectado por un fracaso de un proyecto de un grupo de trabajo local?.
Les agredesco por su tiempo y esfuerzo.
Cordialmente,
Martijn van Dongen
APPENDIX 4: ´´The Financial Market of Mexico´´, by Martijn van Dongen
Mexico’s credit market
In 1982 policymakers in Mexico aggressively opened the country to trade in goods and services following a balance of payments crisis; Mexico adopted a so called ‘’an export and import promotion strategy” in December 1982. In 1985 Mexico joined the General Agreement on Trade and Tariffs, which entailed eliminating tariffs and eliminating non-tariff barriers. In the ensuing years the country signed many more trade agreements; the new strategy took the many advantages that would result from trade liberalization for granted. It assumed that an improvement in technical efficiency would take place once protective trade barriers were eliminated. Previously protected firms would have no choice but to modernize their techniques and cut their costs in order to compete with foreign producers; this should theoretically lead to increased productivity and higher income levels.
Nevertheless with trade liberalization set in motion, the credit expansion was enormous: From 1988 to 1994, credit from local commercial banks to the private sector rose in real terms by 275 percent and credit card liabilities rose at a rate of 30 percent per year. External credit flows to the private sector went up spectacularly while the international reserves of the National Banc of Mexico decreased. A substantial part of the increase in private investment went into unprofitable ventures as leveraged toll-roads, unrecoverable home mortgages, or credit unions that invested with low or negative rate of returns. The attraction of foreign resources and the liquidation of government debt resulted in a higher private aggregate demand, which at its turn resulted in a rising current-account deficit.
The financial sector also underwent a substantial liberalization, which, when combined with other factors, encouraged an increase in the supply of credit of such magnitude and speed that it overwhelmed the weak supervisors, the capital of banks and even borrowers. Several factors contributed to the growth of credit in-flows, as described by Francisco Gil-Diaz (1994):
1. Improved economic expectations
2. A substantial reduction in the public debt 3. A international availability of securitized debt 4. A growth in real estate and in the stock market 5. A strong private-investment response.
Poor borrower screening, credit-volume excesses, and the slowdown of economic growth in 1993 turned the debt of many into an excessive burden. The number of nonperforming loans started to increase rapidly. Adjustment of the balance-sheet position of the private sector and the late adoption by some commercial banks of prudent policies were signs that nonperforming loans had exceeded reasonable dimensions. The underlying reasons for these problems were:
1. The financial sector was liberalized: lending and borrowing rates were freed and bank reserves requirements were eliminated.
2. Banks were hastily privatized, not always in accordance with the fitness and quality of the privatization, either in the selection of new shareholders or top officers.
3. Several banks were purchased without their owners proceeding to their proper
capitalization: Shareholders often leveraged their stock acquisitions.
4. Commercial banks lost a substantial amount of human capital during the years in which they were under the government.
5. Moral hazard was increased by the unlimited backing up of bank liabilities.
6. There were no capitalization rules based on market risks which led to a highly liquid liability structure.
7. Banking supervision capacity was weak to begin with, and it became overwhelmed by the great increase in the portfolios of banks.
8. There was a substantial expansion of credit from the development banks.
In fact the entire banking sector was disturbed by a rather alarmingly series of events in the nineties: control and the regulations on financial and internal control did not appear to be sufficient with fraud and deliberate mismanagement as a result. And just as many European currencies collapsed in 1992 after unrelenting speculative attacks on their narrow exchange bands, the political and economical events of 1994 triggered a loss in international reserves until the exchange-rate limits had to be abandoned in December 1994. Almost all financial organizations were faced with severe losses and many could not prevent a bankruptcy.
As result of the many bankruptcies the trust in the financial sector decreased and the diminished fiduciary value of the peso increased the rise of inflation even more. The instable inflation throughout the years has been a factor pushing up interest rates along the curve. The longer end of the curve has also responded, with 10-year rates near 10.2% in mid-November 2004. The National Bank of Mexico warned not to expect a declining trend in inflation until the approach of the second half of 2005.
Throughout the nineties and beginning of the twenty-first century the Mexican inflation has been more than unstable and financial organizations have been struggling to get out of the red.
The financial climate has reached values that form a severe restraint for a healthy climate for financial operations. The interaction between a national deficit, corruption, weak regulations and a large share of the economic active population engaged in the production of basic products cause structural inflation and a hazardous environment for financial institutions.
The crisis and the inherent inflation caused many formal financial institutions to withdraw
from the Mexican credit market. To reflect the situation as it is now, figure 1 provides some
basic information on Mexico, as presented by Cgap (2004).
The lack of access to credit, due to the withdrawal of the financial institutions, was felt very severely in the agricultural sector where credits often form the beginning of the production- cycle. The Mexican rural areas are characterized by a high concentration of poverty which makes it hard to cope with the requisites for obtaining credit. The entire sector was already weak and the cut of from credit was a big blow. The following characteristics explain why the Mexican agricultural sector struggles with the economical and financial developments:
1. In 1940 to 1965, the agricultural production of Mexico grew at a 7% rate annual, but in the last the 30 years the average growth stagnated at about 1.8% with a large spread around the mean, vis-à-vis a demographic growth of 2.7% during the same period. Moreover, during the last 10 years it faced a situation of frank stagnation which resulted in a decrease of the amount of food per capita of the population by 1%
2. The agricultural growth was smaller than the growth of the population, and as a consequence the volume of food purchased in the international market increased, with an
1 A remark: In Mexico, the term microfinance has a more limited meaning. It refers only to the relatively small community of microfinance NGO that provide credit to formal microenterprises.
Population (millions) 100.9
Population Density (per sq km) 51
GDP per capita (PPP US$) 8430
Total Unemployment (% of labour force) 16 % Employment in Agriculture (% of total employment)
17.7% [2001]
Gross domestic savings (% of GDP) 18.3%
% Population under $2/day (PPP) 24%
Depth of Financial Sector (M2 / GDP) 21.0 Percentage of population served by Microfinance
16%
Regulated microfinance institutions Savings and Loan Cooperatives, Popular Financial Partnerships and, Bansefi (Bank for National Savings & Financial Services) Source: CGAP 2004
FIGURE 1: Mexico, Country Indicators Last Updated: 2004
deficit in the trade balance as result. In order to counter this deficit the Mexican Government decided to open its borders and adopt an import/export strategy, which in general has a negative effect on the relatively not cost-effective agro-industrial sector, as explained by Varian Hall (2002).
3. The Mexican rural areas are characterized by a high concentration of poverty. More than two thirds of the extremely poor in Mexico live in mayor cities. Although the idea was to renovate the country’s agro-industrial sector, the rural population lacks the financial resources to invest in its businesses to become cost-effective and therefore suffers from cheap import products from cost-effective big international firms.
4. Through the years the agro-industry easily expanded its activities and raised its production by occupying more farmland. However agricultural growth can no longer be attained through simply expanding the farmland since good farmland is no longer available.
Not only the agricultural population but a great deal of the entire population lost access to credit through the formal financial sector. The remaining financial institutions struggled with their rates of return trying to avoid bankruptcy and had other things on their mind then serving the poor. Official figures estimate that about 3 million formal enterprises exist in the country, about 2.8 million small or micro. Of this formal sector, only about 100,000 have access to credit from the banking sector. The only option that remained was to turn to government programs and microfinance programs in order to obtain funding. However the government programs are not considered a valuable alternative since the requisites for government funding are quite hard to fulfil and often ambiguous. A few of the most heard reasons why governmental funding is hard to get:
1) Several governmental programs exist but they imply certain rules and specification that differ and sometimes even contradict.
2) Application procedures are usually complicated and quite time-consuming (sometimes up to two years)
3) There are almost no programs that grant a loan aimed at providing working capital.
4) Due to corruption and political instability government programs are not always well planned and are sometimes terminated abruptly.
As a result of the macroeconomic movements the number of Mexican microfinance institutions rose enormously. Some of these new microfinance institutions respected basic accounting principals, others without paying attention to liability or liquidity or whatsoever.
The Mexican Government, in collaboration with the national bank, did try to control the wild grow of Microfinance institutions of different types and sorts. In 1999 a committee of experts in the field of economical and financial science presented a quite confronting report on the functioning of the, at that time, applied laws and regulations concerning credit and saving activities in Mexico.
Following the Framework for internal control systems in banking organizations, as drafted by
the Basle Committee on Banking Supervision (1999) they pointed out certain contradictions
and deficiencies in the regulation of non governmental organizations dedicated to Credit and
Savings. Based on the outcomes of the report the government decided to reform the outdated
Microfinance in Mexico
In 2001, the microfinance sector was reorganized and now there are specific laws and regulations for all activities incorporating loan and credit services. The 2001 law forces former NGOs, financial organizations, small savings cooperatives and private assistance institutions to transform into specialized finance companies. These will be supervised by independent Federations acting as an apex body. The specific outline of the law is still subject to changes due to practical and social impossibilities. Every type of microfinance organization that deploys activities that imply Savings and Credits should be formed as one of the following types:
1) Savings and Loan Cooperative 2) Popular Financial Partnership 3) Commercial Bank
The third options will be left outside the discussion since this is a mere theoretical option; the requisites for establishing a commercial bank are out of reach for the common MFI. The Savings and Loan Cooperative provides savings and loans, facilitates access to credit for affiliated members, supports the financing of micro, small and medium enterprises.
Cooperatives will be assigned different operational levels affecting the size and scope of operations. These levels are determined according to the institution’s assets and liabilities, the number of members or clients, the geographical location and the technical and operational capacity of the institution.
A Popular Financial Partnership provides savings and loans; facilitates access to credit for its members; supports the financing of micro, small and medium enterprises; and in general, foments the social and economic well-being of its members and the communities in which it operates. Partnerships will be assigned different operational levels affecting the size and scope of operations. These levels of operations are determined based upon the same factors as mentioned above. Figure 2 represents the interesting requisites for both the Savings and Loan Cooperative and the Popular Financial Partnership.
Savings and Loan Cooperatives Popular Financial Partnerships
Required legal form of organization
A minimum of 100 members for level 1 operations, 200 members for level 2 operations with variable capital.
Corporations with variable capital. (See General Law for Mercantile
Associations, Art. 1)
Restrictions on ownership
Natural persons cannot hold more own more than 3%.
Individuals and corporations cannot hold directly or indirectly, more than 3% and 10%, respectively, of the institution’s equity.
FIGURE 2: Microfinance in Mexico
Standards for owners and officers
Administration council members must have experience in financial and administrative matters.
The Director/General Manager must have at least three years of financial and management experience unless the institution falls under Level I of operations, in which case the Federation must decide if it is satisfied with his/her credentials.
Administration council members must have experience in financial and administrative matters.
The Director/General Manager must have at least three years of financial and management experience unless the institution falls under Level I of Operations in which case the Federation must decide if it is satisfied with his/her credentials.
Minimum capital There is a broad range of
minimum capital requirements (from US$34,021 to US$8.5 million) based on operational level. (APEC 2002)
There is a broad range of minimum capital requirements (from US$34,021 to US$8.5 million) based on operational level
Minimum capital adequacy/
gearing ratios
8-11% solvency ratio; the more capital, the less the ratio.
8-11% solvency ratio; the more capital, the less the ratio
Reserves, Liquidity requirements
Liabilities must be invested in liquid assets (APEC 2002). 10% of profits must go to a reserve fund until it is equivalent to 10% of total capital. Fund must be invested in highly liquid government securities.
At least 10% of short term liabilities must be invested in liquid assets (APEC 2002). 10% of profits must go to a reserve fund until it is equivalent to 10% of total capital. Fund must be invested in highly liquid government securities.
APPENDIX 5: ´´Internal Information Problems´´, by Martijn van Dongen
This section has been tailored to formal banking institutions more than to microfinance institutions; however the lessons to be learned are clear. Since the organization finds itself within a situation in which asymmetric information exists, financial institutions developed a meta-control system that is supposed to eliminate possible sources of abuse of knowledge, fraud and embezzlement by loan officers and other personnel. Furthermore the meta system ensures the reliability and completeness of reports so decent decisions can be made and it makes certain that no laws or regulations are violated. In fact the internal organization is a governing organ that supervises and regulates the operational part of screening, monitoring and enforcement by the Financial Institutions´ (FI´ s) employees at the operational level, as shown in figure 1.
According to Kramer en De Smit (1991) a governing organ has to meet the following requisites for effective governing:
1. A Goal
2. Model of the governed system 3. Information about governed system 4. A sufficient variety of steering-measures 5. Sufficient information-assessing capacity.
Contextual Demand Contextual Demand
Contextual Demand Organizational Contextual Demand
design to assess and
process information from context
Organizational design tocontrol incentives, activities and correctness Internal information problem
External Information Problem
Figure 1: Governing organ and governed system
The internal control system has to ensure that the FI will be able to face and overcome the problems that threaten its sheer existence; the control system is a complex interaction between the environment and the goals, actors, activities, duties and internal relationships within the organization. Control breakdowns jeopardize the viability of the FI because the organization will not be able to find the right answers to the threats it is exposed to, or worse: it might not even recognize the threat. Control breakdowns are generally categorized into five groups, as discussed by the Basle Committee on Banking Supervision (1999):
1) Lack of adequate management oversight and accountability, and failure to develop a strong control culture within the financial institution.
2)
Inadequate recognition and assessment of the risk of certain banking activities, whether on- or off-balance sheet.
3)
The absence or failure of key control structures and activities, such as segregation of duties, approvals, verifications, reconciliations, and reviews of operating performance.
4)
Inadequate communication of information between levels of management within the financial institution, especially in the upward communication of problems.
5)
Inadequate or ineffective audit programs and monitoring activities.
This annex examines the organizational design of an internal control system that should be able to overcome the problems as presented above. However, it does not intend to give the one and only solution that will solve all problems. There is always more than one solution possible, rather this annex seeks to give the requisites for a possible organizational answer: a general idea about the goals, actors, activities and interdependencies as displayed in the following sections.
§1.1 Goal, Sub-Goals and activities
1) Performance objectives
2) Information objectives
3) Compliance objectives
Goal Sub-Goals Core-Activities
INTERNAL CONTROL
Managing oversight and creation of a control culture
Risk recognition and assessment Control activities and segregation of duties
Creating efficient information and communication
Monitoring activities and correcting deficiencies
Figure 2: Framework of Goal, Sub-Goals and Core Activities
management and all levels of personnel. It is not just a procedure or policy; it is an ongoing process that should be carried out at all levels within the financial institution; each individual within an organization must participate in the process. The main objectives of the internal control process can be categorized as follows:
1. Efficiency and effectiveness of activities (performance objectives)
2. Reliability and completeness of financial and management information (information objectives)
3. Compliance with applicable laws and regulations (compliance objectives).
Performance objectives for internal controls concern the effectiveness and efficiency of the financial institution. The internal control process seeks to ensure that the organization’s personnel is working to achieve its goals with efficiency and integrity, without placing other interests before those of the financial institution.
Information objectives address the preparation of timely, reliable and relevant reports needed for decision-making within the organization. They also address the need for reports and other financial statements of high quality and integrity to all the stakeholders.
Compliance objectives ensure that all financial institution´ business comply with applicable laws and regulations. This objective ensures the viability of the financial institution’s legal personality and its reputation. However to enforce these objectives one needs actors. Loan officers, credit committees and other employees face and assess problems such as adverse selection and moral hazard in the screening and monitoring processes. The financial institution depends on those employees to assess and chart the risks that threaten the existence of the institution if they are not dealt with properly. But how can the organization ensure that the priority of the loan officers lies with the financial institution and that there is no room for opportunistic behaviour? How can these internal control objectives be transcribed into an internal organizational structure? Even if the priority of these employees doesn’t lie with the financial institution, which internal organization can prevent the abuse of knowledge and can eliminate fraud? Two main points are especially important concerning the actors and activities in order to achieve an internal organization that can minimize the risk that corruption, abuse and misbehaving affects its business:
(1) Oversight by individuals not involved in the day-to-day running (2) Independent risk management and audit functions.
Compliance with an established internal control system is heavily dependent on a well documented and communicated organizational ´´aufbau´´ and ´´ablauf´´ ( structure, divisions, authority, decision making power, processes, interdependencies, responsibilities and lines of communication) The allocation of duties and responsibilities should ensure that the interdependencies and interrelated authority, oversight and decision making power are clearly stated; no confusion should be created and there should be no gaps in reporting lines.
Furthermore an effective level of management control should be extended to all levels of the financial institution and its various activities in order to comply with:
- Managing oversight and creation of a control culture - Risk recognition and assessment
- Control activities and segregation of duties
- Creating efficient information and communication
- Monitoring activities and correcting deficiencies
The main objectives of internal control combined with two points mentioned above form the input for figure 3: The Internal Organization
Although the names of groups of actors may differ throughout each organization, they are not really important; their task assignment, independency and responsibilities are the topics that matters. ‘’Allocating the scarce time of actors to the tasks they will perform.’’ is a difficult process and is not always well understood. Each group of actors has a wide range of responsibilities; this annex focuses on the control-aspects only; a short explanation is presented about the risks that have to be mapped properly and communicated correctly to members within the organization and to external actors like the public accountant, as
(2) Credit Committee
Monitors developments and defines consequences
Credit Risk LiquidityRisk
Legal Risk Market Risk
Operational Risk
(4) Board of Directors
Revises policies and establishes new rules and regulations
(3)
A U D I T O R S
(3)
A U D I T O R S
(1) Operational management
Loan officer screens loan-applicants
Figure 3: Internal organization
Credit Risk
Credit risk is most simply defined as the potential risk that a bank borrower or counterpart will fail to meet its obligations in accordance with agreed terms. The goal of credit risk management is to maximize a bank’s risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters. Banks need to manage the credit risk of the entire portfolio as well as the risk in individual credits or transactions. Banks should also consider the relationships between credit risk and other risks. The effective management of credit risk is a critical component of a comprehensive approach to risk management and essential to the long-term success of any banking organization.
Liquidity Risk
Liquidity, or the ability to fund increases in assets and meet obligations as they come due, is crucial to the ongoing viability of any banking organization. Therefore, managing liquidity is amongst the most important activities conducted by banks. Sound liquidity management can reduce the probability of serious problems. Indeed, the importance of liquidity transcends the individual bank, since a liquidity shortfall at a single institution can have system-wide repercussions. For this reason, the analysis of liquidity requires bank management not only to measure the liquidity position of the bank on an ongoing basis but also to examine how funding requirements are likely to evolve under various scenarios, including adverse conditions.
Operational risk
The Basel committee defines operational risk as follows: "the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events". It is important to note that this definition is based on the underlying causes of operational risk. The definition seeks to identify why a loss happened and includes the breakdown by four causes: - -People, processes, systems and external factors. This "causal-based" definition is particularly useful for the discipline of managing operational risk within institutions. However, a key issue in the area of operational risk management, as well as in the development of regulatory capital requirements, is the collection and analysis of data to assess the impacts on the financial statements of the institution. Business-continuity, outsourcing, employment practices, the management of collateral and IT resources are topics highly related with operational risk.
Legal risk
Legal Risk forms a part of the Basel committee’s interpretation of operational risk, but to give an oversight of the responsibilities and tasks, legal risk is presented separately. The definition by the Basel Committee: ‘’The risk that one is unable to enforce rights against, or rely on obligations incurred by the counterparty in the event of a default or a dispute.’’ Problems usually occur in the area of documentation of (property) rights, supervening events and unreliable legal environments.
Market Risk
Market risk is exposure to the uncertain market value of the portfolio. A trader holds a portfolio of commodity forwards. The market value of today can be exactly established, but its market value a week from today is unknown. So the trader will face market risk: the variation of the portfolio’s market value through time. Market risk is managed with a short- term focus. Long-term losses are avoided by avoiding losses from one day to the next. On a more strategic level, organizations manage market risk by applying risk limits to portfolios.
Increasingly, value-at-risk is being used to define and monitor these limits.
§ 2.1 The key actors
Off course just having four independent organs doesn’t make the problems disappear; the actors should be fit and proper for their jobs; they should be able to carry out their task and claim their responsibility without wanting to influence processes that fall outside their jurisdiction. Therefore a small description of the four necessary groups of actors in a financial institution is given in the subsequent sections.
§2.1.1 Operational management
Finance Institution general managers should have experience in managing financial institutions and a have financial or business background. Prior to hiring a manager, each candidate should date and sign a document outlining their duties and responsibilities.
Annually, compliance with this document should be a part of the manager’s appraisal process.
This description of the duties assumes that the financial institution not only has a manager; the institution has other employees like an accountant and a loan officer. The general manager will have to guide and direct these employees in order to run the daily business administration and operations, consistent with the guidelines as formulated by the board of directors but without direct involvement, supervision or guidance of other actors. The operational management should include in its activities:
1) Carrying out the directives of the board of directors, including the implementation of strategies and policies and ensure that employees follow all of the established board policies.
2) Setting appropriate internal control policies; and monitoring the adequacy and effectiveness of the internal control system
3) Maintaining an organizational structure that clearly assigns responsibility, authority and reporting relationships
5) Enforcing appropriate policies and procedure for delegation and ensuring that delegated responsibilities are effectively carried out.
6) Prepare an annual operating budget and cash flow budget with input from the Board.
Loan officers are employees of the financial institution; they report to the general manager.
Extensive experience in underwriting the loan types offered by the credit union is required.
The credit committee should delegate their authority to screen applicants to a loan officer or constitute an independent auditing committee; the following are the job duties and responsibilities of a loan officer or auditing committee:
1) Interview loan applicants, obtain all of the necessary documentation to make the loan decision, properly secure the collateral used to qualify for the loan, and approve the loan.
2) Provide information to the membership concerning the different types of loans offered, the terms and interest rates, and the documentation needed to be considered for a loan.
3) Make loan decisions in a timely fashion to meet member needs.
4) Grant loans according to credit union policy and procedures and in compliance with applicable laws.
5) Provide financial counseling to members in the wise use of credit.
6) Refer all borrower requests for loan extensions, refinances, or any changes to original loan
terms to the credit union manager or as designated in policy.
§ 2.1.2 The credit committee
The credit committee is normally elected by the members at an annual general meeting or they are appointed by the board of directors. The credit committee reports to the board of directors. To guarantee its independence large clients of the financial institution cannot be represented in the credit committee. Members should have knowledge of financial reporting and internal controls and are supposed to facilitate the work of the board of directors. The credit committee should include in its activities:
1) Monitoring development: Ratify and Review all loans over established limits.
2) Review the criticized and classified loans on a regular basis.
3) Assess, and bring forth report about credit, market, liquidity and legal risks
4) Review overall credit policy of the institution on an annual basis and report findings to the Board of Directors
5) Review credit limits for appropriateness.
6) Reviewing and approving audit scope and frequency of internal and external auditors.
§2.1.2 Auditors
Every FI should have some form of internal audit in addition to the annual external accountant-control as elaborated by Sawyer (1996). Besides other benefits as presented below, internal auditing can significantly lower these external audit costs. External auditors can narrow the scope of their testing procedures if they find that reliable internal audit procedures are in place. Internal auditing has been defined as a systematic, objective appraisal by internal auditors of the diverse operations and controls within an organization for the purpose of assisting members of the organization in the effective discharge of their responsibilities to determine whether:
1) Financial and operating information is accurate and reliable 2) Risks to the enterprise are identified and minimized
3) External regulations and acceptable internal policies and procedures are followed 4) Satisfactory operating criteria are met
5) Resources are used efficiently and economically 6) The organization’s objectives are effectively achieved
However, small financial institutions will seldom find it cost-effective to hire a qualified full- time internal auditor. According to CGAP material, a professional internal auditor becomes interesting when the financial institution has a hundred or more employees. If the financial institution hasn’t reached this stage yet, they tend to contract out their internal audit function, sometimes to the same external audit firm that performs the annual financial statement audit.
In most cases the external audit firm sends a junior staff member to the MFI on a regular basis
to perform the internal audit, and a senior manager at the audit firm supervises his or her
work. For a small MFI this arrangement not only saves money, it also brings the backing of a
recognized audit firm, which may provide an extra margin of comfort for directors and
managers. A downside of this approach is the possibility of a conflict of interest when the
audit firm takes responsibility for setting up an accounting system that it is later supposed to
evaluate in the external audit. The differences between in-house and out-sourced internal
auditing, as stated by CGAP (1998) are presented in Table 1.
§2.1.4 Board of directors
Board members should be objective, capable, and inquisitive, with a knowledge or expertise of the activities and risks run by the financial institution. A strong, active board provides an important mechanism to ensure the correction of problems that may diminish the effectiveness of the internal control system. The board of directors should include in its activities:
(1) Periodic discussions with management concerning the effectiveness of the internal control system.
(2) A timely review of evaluations of internal controls made by management, internal auditors, and external auditors.
(3) Periodic efforts to ensure that management has promptly followed up on recommendations and concerns expressed by auditors and supervisory authorities on internal control weaknesses.
(4) A periodic review of the appropriateness of the financial institution’s strategy and risk limits and giving order to an external accountants-control.
§2.1.5 Preventing fraud, conflicts of interests and minimizing risks
Each group of actors and its responsibilities has been introduced, but how can they prevent the occurring of fraud when each one of the groups might have incentives to not report the truth? Fraud control is an important issue for all financial institutions. Although many small financial institutions have social goals and motives this doesn’t prevent them form fraud or conflicts of interest; few people are always honest, few people always dishonest: most people fall somewhere in between.
The primary sources of fraud in micro credit institutions include phantom loans, kickback schemes and other bribes, and non-reporting of client payments. These risks are augmented by
Table 1: Differences between internal and external auditors
Nevertheless when a loan officer makes loans to nonexistent businesses or to existing businesses that are acting as a “front, the audits of paper trails do not detect timely this unethical behavior until the accumulated debt becomes too big and the loan officer won’t be able to manipulate it any more, but at this time the damage is already done.
The difficulty of detection lies in the fact that the loan officer alone is responsible for generating and following through on loans until the point where the loan becomes largely overdue. This can take weeks, or months in organizations where repayment culture is lax.
For someone else than the loan officer, the only way to distinguish a fraudulent delinquency from a normal delinquency is to visit the client.
To avoid and prevent fraud and thus providing financial services in a viable and effective way requires considerable decentralization of authority and the independence of each control agent within the organization. Each independent group of actors assesses and judges the information produced by the preceding group of actors thereby exposing and thus eliminating or at least reducing fraudulence behaviour, as shown by Figure 4.
The interaction of an internal control system as promoted in figure 2 and independent actors as promoted in figure 4 should not only guarantee a proactive attitude towards the risks involved in repayments and fraudulence employees; the internal organization should assess the overall risks and threats that endanger the institution. It should be able to assess and evaluate the reasons for all future risks, the probability of the risk actually occurring and the damage of the impact prior to the actual impact. Subsequently the internal organization should be able to adjust its regulations in a timely matter so it can prevent the actual event from happening. Figure 5 shows this double loop-learning process as the final result of an appropriate internal organization.
1) Loan officer screens applicants based on rules established by Board
of Directors
2) Credit committee monitors development of loan-payback and
assess the risks involved
4) Board adjusts strategies and rules based on reports by Operational Management, internal and external
auditors and Credit Committee
3) Auditor controls correctness of paper trials, financial statements and risk assessments of screening
and monitoring agents Annual external
accountants-control
Figure 4: The Circle of control
