Operational risks are the vulnerabilities confronting a microfinance institution in its daily operations that can ultimately result in the loss of its assets. At its core, an operational risk is the concern that an MFI will lose its money through bad loans, fraud and theft. This chapter describes controls and monitoring activities to reduce
the three types of operational risks summarized in Figure 9.
To reduce vulnerability to operational risks, microfinance institutions develop policies and procedures that form the core of the organization’s internal control system. These controls usually include preventive and detective aspects. Preventive controls inhibit undesirable outcomes from happening. Examples of preventive controls include:
Í Hiring trustworthy employees who can make good credit decisions
Í Ensuring that loans are backed by appropriate collateral or collateral substitutes
Í Segregating staff duties to prevent intentional wrongdoing
Í Requiring authorization to prevent improper use of resources
Í Maintaining proper record keeping procedures to deter improper transactions
Í Installing sufficient security measures (i.e., locks, guards, safes) to protect cash and other assets
Detective controls identify undesirable outcomes when they do happen. Examples of detective controls are:
Í Reconciling bank statements with cash receipts
Í Monitoring early warning signals for signs of pending portfolio quality problems
Í Implementing delinquency management policies to prevent late payments from escalating into bad debts
Í Monitoring staff performance to ensure policies and procedures are followed
Í Visiting clients to ensure that their loan and saving account balances and transaction dates correspond with the MFI’s records
Arriving at the appropriate balance of preventive and detective controls involves judgment. Preventive controls avoid problems before they occur, but detective controls are generally easier to implement. For example, it is easier to do monthly bank reconciliation than to prevent employees from pocketing repayments.
There are also important cost implications to consider. MFIs cannot eliminate losses due to operational risks. Some loans are bound to go bad and some staff members will undoubtedly succumb to temptation. Controls designed to minimize the losses from operational risks need to be carefully analyzed for their cost-effectiveness—some controls may be more expensive than they are worth.