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A Research Report in Partial Fulfilment of
The Requirements for the Degree
Master of Business Administration
HONG RY July 2011
KINGDOM OF CAMBODIA NATION RELIGION KING NORTON
GRADUATE SCHOOL r } s
FINANCIAL RISK MANAGEMENT OF CREDIT
MICRO FINANCE INSTITUTION
FINAANCIAL
MICR
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By
HONG RYJuly 2011
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EDIT
ii
APPROVAL SHEET
This Research Report entitled Financial Risk Management of CREDIT Microfinance Institution was
prepared and submitted by HONG RY in partial fulfilment of the requirements of the degree
Master of Business Administration
Approved by the Committee with a grade of ____________
RESEARCH REPORT SUPERVISORY COMMITTEE
Chairperson of Committee : _________________________ Dr. Ung Vannthoeun Committee Member : _________________________ Dr. ………………………… Committee Member : _________________________ Mr/Ms. ……………………
Course Facilitator : _________________________ Dr. Ung Vannthoeun Date of Research Report submission _________________________
Accepted in partial fulfilment of the requirements for the degree Master of Business Administration
(MBA)
_________________________ David A. Clarke, Ph.D
Dean of the Graduate School
iii
ABSTRACT
By seeing the growth of CREDIT with increasing the complexity in its operations and
financial activities, the researcher decides to conduct the research report study on the topic of
“Financial Risk Management of CREDIT”. The objectives of this research report is to realize
the significance of financial risk management, describe the real practices of financial risk
management, and find out limitations of financial risk management in CREDIT based on
answers from interviewing CFO and RCUM in July 2011, draft risk management policy in
2011, financial statement in the period of year 2009 and 2010, accounting and treasury
policies in 2010, ALCO reports for March 2011.
In this research study the researcher used two types of significant data, primary data
and secondary data. This research study is a qualitative designed and cross sectional study.
For the data collection of this research the researcher collected based on the questionnaires
for both of primary and secondary data and the data analysis of this research is situational
and process analysis.
The research result shows the significance of financial risk management to CREDIT
such as helping the management pre-estimate the cash need or financial projection
effectively, helping management team in identifying and putting in place the effective controls
for managing financial risks, enabling management to create a strategy that accounts for a
field with multiple players, and helping managers in deciding what levels of risk are
acceptable and set limits to maintain asset and liability mismatch. In real practice, CREDIT
manages its financial risks through financial statement with including some ratios that
represent the financial risks for CREDIT, Asset/liability management tables, ALCO
committee, risk management policy, and accounting and treasury Policies and other
instruments. Also, the limitations in implementing the financial risk management in CREDIT
iv
includes limited risk management resource, limited risk management concept of senior
management, poor concept of staff in risk management, add more burdens for staff, too many
controls, and cost increase.
As conclusion, the financial risk management of CREDIT is in small size w but it is in
best fit to current operation size of CREDIT. In addition, the researcher gives some
recommendations to CREDIT such as establishing the separate financial risk management
policy, setting up the risk threshold for its financial activities, building the staff capacity in
subject of risk management, seeking more the advice from external consultants, and strongly
supporting the risk management function and actively participating in building risk
management cultures from management.
v
ACKNOWLEDGEMENTS
First of all, I would like to be immensely gratitude to my parents who worked hard to
bring up strictly and send me to school from primary school to university. Second, I would
like to be gratitude to my uncle and aunt for their kindness in offering me the accommodation,
food, and other supports while studying at university and a few years afterward. Third, I
would like to show my love to my grandmother and father who have advised me so far.
Fourth, I would like to show my love to my wife and daughter who are crucial parts of my life
and make me the life enjoyable and fully encouraged. Also, I would like to express thanks to
CREDIT for partially supporting my MBA study, providing secondary data, allowing me to
interview related to this research, and showing patience to me to get this report successfully.
My special thank goes to Prof. Dr. Ung Vannthoeun, Norton University Vice Rector
and current adviser, for his best advice, and strong support, particularly for my MBA research
report at Norton University.
Finally I am grateful to everyone who has lent a helping hand, I would like to stress
that I take full responsibility for the views I express in this report and for any errors of
judgment or interpretation that remain.
vi
TABLE OF CONTENTS
TITILE PAGE ............................................................................................................................ i
APPROVAL SHEET ................................................................................................................ ii
ABSTRACT ............................................................................................................................. iii
ACKNOWLEDGEMENTS ....................................................................................................... v
TABLE OF CONTENTS ......................................................................................................... vi
LIST OF TABLES ................................................................................................................... ix
ACRONYMS ............................................................................................................................. x
CHAPTER
INTRODCUTION
1.1. Background and rationale of the study ........................................................................... 1
1.1.1 Background of CREDIT Micro Finance Institution .............................................. 1
1.1.2. Rationale of the study ............................................................................................ 5
1.1.3. Problem statement and objectives ......................................................................... 6
1.1.4. Scope and limitation of study ................................................................................ 6
1.1.5. Benefits/Significance of the study ......................................................................... 7
CHAPTER II
LITERATURE REVIEW
2.1. Term Definitions ............................................................................................................. 8
2.2. Financial Risk Management ............................................................................................ 9
2.1.1 The Benefits of Financial Risk Management ........................................................ 9
2.1.2 Types of financial risk ......................................................................................... 10
2.1.3 Tools for measuring and Managing Financial Risk ........................................... 11
2.1.3.1 Asset/Liability Management Tables .................................................................... 11
vii
2.1.3.2 Asset-Liability Committee (“ALCO” or “Finance Committee”) of a board ....... 16
2.1.3.3 Financial Risk Management Policy ..................................................................... 18
CHAPTER III
RESEARCH DESIGN AND PLANNING
3.1. Research Framework ..................................................................................................... 27
3.2. Research Methodology ................................................................................................. 28
3.2.1. Research Design .................................................................................................. 28
3.2.2. Data Collection .................................................................................................... 28
3.2.3. Data Analysis ....................................................................................................... 29
3.3. Organization of the study .............................................................................................. 29
CHAPTER IV
DATA PRESENTATION AND ANALYSIS
4.1. Introduction to Financial risk and the important of financial risk management ........... 31
4.2. Practice of financial risk management in CREDIT....................................................... 33
4.2.1. Financial statements ............................................................................................ 33
4.2.2. Asset/liability management ................................................................................. 37
4.2.3. Risk Management and other policies .................................................................. 45
4.2.4. ALCO committee ................................................................................................ 49
4.2.5. Other instruments ................................................................................................ 50
4.3. Limitation in financial risk management in CREDIT ................................................... 51
CHAPTER V
CONCLUSION AND RECOMMENDATION
5.1. Conclusion .................................................................................................................... 53
viii
5.2. Recommendation .......................................................................................................... 54
REFERENCES .................................................................................................................. 56
APPENDIX .......................................................................................................................... 58
ix
LIST OF TABLES
Table 1 Liquidity risk Table
Table 2 Interest Rate Risk table
Table 3 Liquidity risk Table
Table 4 Suggested Financial Risk Appetite /Threshold form
Table 5 Liquidity Risk (Maturity Risk) of CREDIT
Table 6 Interest Rate Risk (Repricing Risk) of CREDIT
Table 7 Foreign Currency Risk of CREDIT
Table 8 risk indicators required by NBC
x
ACRONYMS
ALCO Asset and liability committee
AML Asset/Liability Management
CAR Capital Adequacy Ratio
CEO Chief Executive Officer
CFO Chief Finance Officer
COF Cost of fund
COO Chief Operational Officer
Excom Executive Committee
FCY Foreign Currency
FX Foreign Exchange
IAM Internal Audit Manager
IRR Interest Rate Risk
KHR Khmer Riel
LCY Local Currency
LIBOR London Interbank offer rate
MFI Micro Finance Institution
NBC National Bank of Cambodia
NOP Net Open Position
PPE Plant Property and Equipment
RCUM Risk and Compliance Unit Manager
RM Risk Management/ risk manager
RMC Risk Management Committee
1
CHAPTER I
INTRODCUTION
1.1. Background and rationale of the study
1.1.1 Background of CREDIT Micro Finance Institution
Cambodia Rural Economic Development Initiatives for Transformation (CREDIT) is a
Christian Microfinance Institution and was initiated by World Relief Cambodia, an
international non-profit organization registered with the Ministry of Foreign Affairs in
Cambodia.
CREDIT was established by World Relief US in 1993 to provide sustainable financial
services to Cambodia's poor entrepreneurs. The institution has a triple bottom line embracing
sustainability as well as enabling its clients to achieve socio-economic and spiritual
transformation CREDIT became a licensed microfinance institution in May 2004. In just a
few short years, it has grown to very fast in terms of loan outstanding and numbers of clients
while keeping very high quality of loan. As of March 2011, CREDIT are serving 50,452
active borrowers with loan outstanding USD34.92 millions. To maximize the impact on poor
clients, CREDIT is working with some development partners to provide other complementary
services to clients such as debt management, savings, and budgeting. Other trainings: primary
health care, agricultural training, and awareness of HIV/AIDS have been trained to clients by
our NGO partners. CREDIT partners include Kiva, Tear Fund New Zealand, Eriks, Tear
Netherlands, International Development Enterprise (IDE), Hagar Cambodia, Clear Cambodia,
Green Agricultural Product, etc. and now CREDIT are looking for other development partners
so that our clients can get much more benefits. Now, about 20% of our clients are getting
both: finance and non finance services from CREDIT and partners. The institution is
continually improving in efficiency, outreach, products and services development,
2
technologies and staff capacity building. This improvement is evidenced by successfully
localized management and outstanding financial performance ratios. CREDIT has also
received some international recognition and awards such 2 years in a row received Merit
Award from CGAP on financial transparency. The last rating conducted by Planet Rating, the
world leader in rating microfinance institutions, a step upward, B+, from the last rating. This
shows great improvements achieved within the last 2 years. Social performance rating was
also done this year so that we can improve more social work.
SHAREHOLDERS
List of shareholders and amount of share capital 2010
Nο Descriptions Paid-up capital (KHR) Percentages 1 World Relief US 9,163,600,000 81.66% 2 World Relief Canada 1,434,800,000 12.79% 3 World Hope International 622,800,000 5.55%
Total 11,221,200,000 100%
1. World Relief US, a founder of CREDIT and the majority and outright decision
making shareholder in CREDIT.
For over 60 years, World Relief has been equipping churches and communities to
help victims of poverty, diseases, hunger, war, disasters and persecution. It has
widespread programs in micro enterprise development, child survival and
development, AIDS ministries, disaster response, agricultural projects, refugee
care, immigrant assistance, and trafficked victims protection. As part of its
extensive work, World Relief has implemented income generation for more than
twenty years and has excelled in starting and growing MFIs in some of the world’s
most challenging environments.
3
2. World Relief Canada, a co-founder of CREDIT and the second
majority shareholder in CREDIT.
World Relief Canada partners with the Evangelical Church in Canada and overseas
to respond to the basic needs of the world’s most oppressed, poor and suffering
people, empowering them to meet their own needs in the name of Jesus Christ.
World Relief Canada was founded in 1982, and works with and through local
networks throughout the world, ensuring that local leaders are made partners in
meeting local needs.
3. World Hope International, newly invested in CREDIT and owns 5.55% of
CREDIT registered share capital. World Hope International is a faith based relief
and development organization alleviation suffering and injustice through
education, enterprise and community health. In collaboration with faith
communities, like-minded organizations, and individuals around the globe, World
Hope International seeks to empower people by creating a broad spectrum of
locally sustainable programs. These programs including economic development,
leadership and skill trainings, child sponsorship, and community health education.
By the year 2007, World Hope International creates World Hope Micro-Capital
Fund LLC for investing in MFI partners.
FINANCE DEPARTMENT
Finance Department is one of the six departments in CREDIT. The main financial
objective of finance department is to control the resources to ensure efficient and effective
use. Achieving the objective will help Board of Director and Senior Management Team to
maximize the shareholder’s wealth including: profit maximization, growth, market share, and
social responsibilities. Therefore, the recommendations must be on-going provided by looking
4
into the broader economic environment in which CREDIT operates and the potential risks
associated with the decision and methods of managing the risks.
The finance department is committed to:
Providing accurate and on-time financial reports for stakeholders to make a
better decision.
Ensuring the internal control system is in place.
Meeting the requirements from the National Bank of Cambodia, Tax
Department, and the standard required.
Assisting the External Auditor to produce the fair and transparent financial
reports.
Ensuring the investment and finance decision are made in the proper way.
The Accounting Unit and Treasury Unit are the main functions of finance department,
which enable the department to manage the finance efficiently and effectively. In year 2009,
treasury policy was developed as plan and then approved by BoD for use.
FINANCE DEPARTMENT STRUCTURE
Chief FinanceOfficer (CFO)
Deputy Finance Manager (DFM)
Treasury Unit Manager Accounting Unit Manager
Treasury Officer
Senior Treasury Officer Cashier Accountants
5
1.1.2. Rationale of the study
The MFIs’ businesses are increasing from day to day and face credit risks, financial
risks, and operational risks in daily operational activities. These risks are highly
interdependent and events that affect one area of risk can have ramifications for a range of
other risk categories. Normally, those matured and new MFIs pay attention on, allocate
resources, and put in place the comprehensive control tools for managing the credit risk and
operational risk by less focusing on financial risk which is the consequences from financial
risk has the similar level as credit risk and operational risk. Beyond, less attention on financial
risk, both human and material resources are scarce. In the real context of intensive
competition among MFIs in Cambodia, any MFI that run their business without identifying
and managing the risks adherent to business effectively and equally would resulting the
negative effect to its operation and financial sources and would affect the whole microfinance
sector in Cambodia.
By recognizing the importance of internal control system and risk management
framework, the National Bank of Cambodia has issued the PRAKAS on The Internal Control
of Bank and Financial Institutions in order to require the all banks and Micro Finance
Institution to establish the effective internal control system and risk management framework.
To contribute in promoting and bringing the attention on risk management framework,
especially financial risk management, researcher has decided to conduct a research paper on
Financial Risk Management of CREDIT.
Consequently, this research paper will to bring you to realize the significance of
financial risk management, financial risk management tools, and the limitation in financial
risk management in CREDIT.
6
1.1.3. Problem statement and objectives
While the Banks and MFIs rapidly growing in the limited consumption of their
products and services with their operation more complex would link their operations to the
greater risks especially credit risk and financial risks. In order to address the above-mentioned
concerns about great exposure of financial risks which increase among MFIs as the fact that
MFIs and society concern. This research paper is willing to illustrate the real practice of
financial risk management as many as possible throughout CREDIT. Thus, this research study
raises five questions as follows:
1. What is the nature of financial risks in CREDIT? And how they occur?
2. How important is financial risk management to CREDIT?
3. What is management’s attention on financial risk management?
4. Are financial risks managed in CREDIT? And how financial risks were
managed in CREDIT? What tools was utilized in measuring and managing
financial risks?
5. What is the limitation in financial risk management in CREDIT?
In order to respond the five questions above, this research study focuses on the
following objectives:
1. To realize the significances of managing financial risk to CREDIT
2. To describe the real practice of Financial Risk management in CREDIT
3. To find out the limitations of Financial Risk Management in CREDIT.
1.1.4. Scope and limitation of study
This research shows some financial ratio analysis which link to financial risk
management and risk control of CREDIT based on financial statement, income statement and
balance sheet in the period of year 2009 and 2010. The study will focus on assets liability
7
management, liquidity risk, foreign exchange risk, and interest rate risk, and was not cover the
inefficiency and system integrity and other risks which categorized into financial risk as
mentioned by other different documents . For the level of reliable of the information of this
research is not widely broad. It just base on the information derived from interview with CFO
and RCUM on 01 July 2011, financial statement in 2009 and 2010, ALCO reports for March
2011, draft risk management policy in 2011, accounting and treasury policies in 2010 of
CREDIT, and motioned references.
1.1.5. Benefits/Significance of the study
This research study is very significant to find out and show the real practice of
financial risk management of the company; especially reveal the practical techniques or tools
implemented by the company day-to-day to manage its financial sources for profitability and
social performance effectively and efficiently.
Additionally, this study will help to expand empirical knowledge to readers such as
students who want to research the same or similar topic as a basic knowledge or references
and for anyone who is willing to work for CREDIT which it can serve as the basic knowledge
on a small part of information on CREDIT.
For other microfinance institution staffs and businessmen who wish to understand
about how to manage their financial source and funding effectively and efficiently, they can
use this research for a basic understanding to apply to the real practice in the business or
carrier. This research can also help CREDIT to improve and develop the effective financial
risk management for its financial activities in the future through the recommendation that the
researcher will write in Chapter V.
8
CHAPTER II
LITERATURE REVIEW
In this chapter, four parts will be raised and described. First, it is about the term
definitions, theories of financial risk management, asset/liability management, and financial
ratios.
2.1. Term Definitions
Risk is an ‘uncertainty of outcome that affects the objectives’ that is a two-sided coin,
on one side it has threat, and on the other it has opportunity.
Risk management (RM) is an integral part of a financial institution’s strategic
decision-making process which ensures that its corporate objectives are consistent with an
appropriate risk return trade-off.
Risk Register/Risk management matrix is a documented record of each risk
identified. It specifies: a description of the risk, its causes and its impacts; an outline of the
existing controls; an assessment of the consequences of the risk should it occur and the
likelihood of the consequence occurring, given the controls; a risk rating; and an overall
priority for the risk.
Risk appetite is the quantum of risk that CREDIT is willing to accept and manage
within its overall capacity.
Risk Owner is person who takes the lead responsibility for addressing the risk in
question. Whilst they may assign specific actions to others, they must ensure that the risk is
appropriately dealt with.
Internal control comprises the plan of organization and all methods and measures
adopted within the organization to ensure that resources are used consistent with regulations
and policies; resources are safeguarded against loss, wastage and misuse; financial and non-
9
financial information are reliable, accurate and timely; and operations are economical,
efficient and effective.
Internal auditing is a management tool used to review accounting and financial
activities and to detect and prevent fraud and irregularities. It functions as an independent
review and appraisal of operating activities.
Financial Covenant is part of the conditions of a loan agreement, these covenants are
the promises by the management of the borrowing firm to adhere to certain limits in the firm's
operations. For example, not to allow certain balance sheet items or ratios to fall below or go
over an agreed upon limit.
2.2. Financial Risk Management
Financial risk management is the process of evaluating and managing current and
possible financial risk at a firm as a method of decreasing the firm's exposure to the risks
which arise from the mismatch of asset and liability currencies (foreign exchange risk),
maturities (liquidity risk), and repricing (interest rate risk). It involves assessing the financial
risks facing an organization and developing management strategies consistent with internal
priorities and policies.
2.1.1 The Benefits of Financial Risk Management
The same as risk management, effective financial risk management can provide
management team or business owners the following advantages:
Early warning system for potential problems - By identifying problems early,
there is less of a drain on resources and time. This means more time and money to
finance production and growth.
10
Efficient resource allocation - It allows management to quantitatively measure
risk and fine tune capital allocation and liquidity needs. This helps to maximize
earnings.
Better information - By determining the risks, the organization sets up systems
that generate information on the potential consequences of certain activities in
order to choose the most appropriate activity.
2.1.2 Types of financial risk
Liquidity or Maturity Risk: Liquidity is often defined simply as the ability to
meet maturing obligations (Current Assets > Current Liabilities) or “The ability to
fund obligations on a timely basis as they come due, to accommodate business
growth and acquisitions, and to fulfill obligations under stress conditions”. An
MFI can be unprofitable for one quarter and still be in business, but it could not
survive being illiquid. This usually arises from management's inability to
adequately anticipate and plan for changes in funding sources and cash needs.
Good liquidity management requires maintaining sufficient cash reserves on hand
while also investing as many funds as possible to maximize earnings. The greatest
concern for an MFI is if it is taking deposits then it must maintain confidence in
the institution or face a run on the bank.
Interest Rate Risk: Interest rate risk is the primary measure of market risk on an
MFI’s loan portfolio. It is the risk that an unfavorable change in interest rates
might have on the MFI’s earnings, based on gaps that exist in the matching of its
interest rates on its loan portfolio assets and funding liabilities. Interest rate risk
arises when the cost of funds goes up faster than an MFI can adjust its lending
11
rates. Banks and MFIs have a separate Treasury Department whose main function
is to manage the risk with interest rate changes.
Foreign Exchange Risk (FX): This is the potential for loss of earnings or capital
resulting from fluctuations in currency values. MFIs often experience this risk
when they borrow or mobilize savings in one currency and lend in another. This
risk occurs when there is a currency mismatch in the MFI’s assets and liabilities
that exposes it to FX rate fluctuations that could cause either losses or gains.
2.1.3 Tools for measuring and Managing Financial Risk
In MFIs, the key tools to measure and managing financial risk are a simple set of asset
and liability matching tables, a financial risk management policy, and asset and liability
committee (ALCO).
2.1.3.1 Asset/Liability Management Tables
ALM refers to the matching of an institution’s underlying financial assets and
liabilities, which minimizes its exposure to risk and potential earnings losses. ALM tables are
important components of microfinance financial risk management strategy and monitoring.
They provide visual, useful presentation to assess risks inherent in asset and liability structure.
ALM focuses on measuring and managing risks arising from factors beyond any
organization’s control, such as foreign exchange rate volatility, interest rate volatility, and
availability of funding (liquidity), all of which are a function of the supply and demand for
money in the global economy.
The Liquidity Risk table measures liquidity risk based on maturity of MFI assets
and liabilities. This table helps an MFI to determine where funding gaps exist,
allowing it to adjust maturities as possible, and plan for its liquidity needs. The
format of liquidity risk table is in table 1: liquidity risk.
12
Interest Rate Risk Table looks at any mismatch when an MFI’s assets and
liabilities interest rates reprice. The assets and liabilities in this table are based on
the date their interest rates reset, not the maturity date. This table reflects the
timing difference on an asset (such as a client loan) or a liability (such as a loan
from a commercial bank) and also shows the difference between the underlying
interest rates at which an asset or liability is priced, including variable interest rates
such as a loan in US dollars that is variable based on LIBOR or a euro loan based
on EURIBOR. Table 2: Interest Rate Risk
13
Table 1: Liquidity Risk
< 1
month 2
months 3
months 4
months 5
months 6
months 7
months 8
months 9
months 10
months 11
months 12
months 13-18
months 19-24
months 2-5
Years > 5
years No
Maturity Total
Assets
Cash
Saving Deposit
Term Deposits
Loan Portfolio, net1
Fixed assets2
Other assets
Total Assets
Liabilities
Saving deposits
Term Deposits Loans payable (principle)
Interest payable
Other liabilities3
Total Liabilities
Total Equity Total Liabilities & Equity Asset - (Total Liability + Equity) Gap4
Cumulative Gap Notes:
1. Shows the client loan portfolio as having no maturity. 2. Other assets includes accounts receivable which are shown as <1 month 3. Other liabilities include one month of salaries and other operating expenses. 4. Note that this number is not 0, indicating that the balance sheet doesn't balance. This is due to the additional interest payable to the maturity of funding loans, which is included in this gap analysis but not on the
balance sheet.
14
Table 2: Interest Rate Risk
< 1
month 2
months 3
months 4
months 5
months 6
months 7
months 8
months 9
months 10
months 11
months 12
months 13-18
months 19-24
months 2-5
Years > 5
years
No interest sensitive
Total
Assets
Cash
Saving Deposit
Term Deposits
Loan Portfolio, net1
Fixed assets
Other assets2
Total Assets
Liabilities
Saving deposits
Term Deposits Loans payable fixed rate Loans payable variable rate
Other liabilities3
Total Liabilities
Total Equity Total Liabilities & Equity Asset - (Total Liability + Equity) Gap
Cumulative Gap Notes:
1. The client loan portfolio is assumed to never reprice due to changes in costs of funds. 2. Other assets include accounts receivable. 3. Other liabilities include one month of salaries and other operating expenses.
15
The Foreign Currency Risk table provides valuable information regarding an
MFI’s aggregate exposure to foreign exchange risk caused by potential volatility in
exchange rate movements. Risk exposure is measured by looking at the asset and
liability foreign currency holdings in an MFI’s balance sheet.
Table 3: Foreign Currency Mismatch Table EUR LCY Other FCY Total
Assets Cash Saving Deposit Term Deposits Loan Portfolio, net Fixed assets Other assets Total Assets Liabilities Saving deposits Term Deposits Loans payable Other liabilities Total Liabilities Total Equity Total Liabilities & Equity Net open position (A - TL and Equity) Net open position as % equity
Assets/Liabilities Prudent guidelines recommend: 1) A ratio of foreign currency assets to foreign currency liabilities of no greater than 1.1 and no less than 0.9.
16
2.1.3.2 Asset-Liability Committee (“ALCO” or “Finance Committee”) of a
board
The ALCO is the special committee of the board focused on the MFI’s financial
condition, liquidity and risks. It reviews the financial reports produced by the finance
department and oversees any financial related regulatory requirements. Its goal is oversight
and supervision – with decision making delegated to management.
ALCO membership: The ALCO is often the same as the MFI’s senior
management team or a subset of that team. The ALCO could be a board-level
committee or a senior management-level committee with representation from the
board of directors depending on the level of sophistication of senior management
and of board members, and depending on local regulatory requirements. In all
cases, the ALCO is an operational committee, so this committee’s members should
be included individuals with very familiar with the daily operations of the MFI
(senior management), prior funding experience (bankers, finance managers,
lawyers), who can add value in reviewing the merits and risks of new funding
proposals and share their knowledge of the banking environment, capital markets
and investment management.
Roles and responsibilities: The ALCO should ensure that managers from both
sides of the balance sheet—credit or operational head, manager in charge of
deposit products, finance manager (typically responsible for negotiating new
funding)—meet regularly and understand how actions on one side of the balance
sheet affect the other side of the balance sheet and the overall financial risks of the
organization. Once risk appetite is set, the ALCO will ensure that new products or
17
new sources of funding will not increase the exposure of the MFI to foreign
exchange, interest rate, or liquidity risk.
The ALCO does the following:
Ensures that senior management and the board of directors
understand and approve all reports related to ALM, including the
assumptions and logic used to create them.
Recommends limits, ratios, and targets for liquidity, interest rate,
and foreign exchange risk for board approval and in line with the
MFI’s risk appetite.
Ensures that there is always adequate liquidity to meet the
organization’s maturing obligations and growth projections and also
that there is a liquidity reserve in case of emergency.
Meets monthly or more frequently as needed to review exposures,
including year-to-date trends, significant monthly variances, any
cause for concern, or need to change limits or indicators
Discusses and updates funding strategy and costs.
Discusses any internal policy changes or external regulatory
changes that affect the financial risk management of the MFI.
Reviews any new products or funding sources, and ensures they are
correctly reflected in ALM reports.
Discusses and manages any human resources issues related to
financial risk management.
ALCO meetings and reports: The meeting should follow the same format each
month, to ensure consistency and also to ensure that all members become familiar
18
with the reports, exposures, and limits and how they change over time. ALCO
minutes are essential to document discussions, agreements, and action plans and
will become the auditable record of ALCO activity. Reports necessary for such
committee meetings should include:
1) financial statements (balance sheet and income statement),
2) cash projections,
3) debt summary schedule,
4) investment summary schedule,
5) financial policy exceptions,
6) new debt or funding proposals for review,
7) liquidity ratios summary report, and
8) asset-liability management (ALM) reporting.
Annually, the full board should review the financial risk management policy and make
recommendations.
2.1.3.3 Financial Risk Management Policy
A financial risk management policy is different from a finance policy, inasmuch as it
will specify financial risk indicators and measures to be tracked rather than financial
performance indicators.
The policy template has presented four core elements for managing financial risk:
1. Introducing key structures, in terms of the RMC and ALCO. It
outlines roles and responsibilities of the board and the senior
management team related to financial risks. The board of directors
typically will approve the policy, including the methodologies for
calculating limits and the limits themselves. The policy may establish
19
an ALCO and define who sits on it, how often it meets, and its
responsibilities. Board members and senior managers who are
responsible for financial risks should have a good understanding of
how those risks are measured, because logic and assumptions used to
create reports and calculate ratios will drive limit setting and decision
making within the organization.
2. Balance sheet account approach to measuring the levels and
concentrations of financial risk by individual accounts. Some
examples of financial risk indicators are concentration ratios for
liquidity and profitability impact ratios for foreign exchange and
interest rate risk.
3. Asset-liability management (ALM): measuring the risk in the
relationship between these individual accounts. The risk can be
measures and identified its relationship through ALM tables such as
maturity risk table, interest rate risk table, and foreign exchange risk
table. Defining risk appetite—how much financial risk an institution is
willing to take to reach its profitability targets—is key for AML. The
suggested financial risk appetite or threshold form is Table 4.
4. Liquidity and cash management: measurements, monitoring, and
projection of liquidity needs. Liquidity and cash management is
comprehensively managed under the liquidity and cash management
policies which cover: identifying liquidity risks, measuring and
controlling liquidity, and monitoring liquidity.
20
However, a strong financial risk management policy will not only avoid potential risks
and losses to their institution, but will also optimize their access to funding and instill
confidence in regulators and raters. Likewise, financial risk management policy should be
reviewed and updated annually or as needed given the introduction of new products or
services.
21
Table 4: Suggested Financial Risk Appetite /Threshold form
Risk Indicators Formula Explanation Acceptable level
CASH MANAGEMENT AND INVESTMENT
Deposit with single bank Deposit with single bank
Total Deposit
Deposit cash with preferably the three top-rated banks/financial institutions (or at minimum, a highly rated institution) in the country and limit deposits with a single bank to no more than [33 1/3%] of an MFI’s deposits. Also, confirm the deposit insurance coverage these banks may have for your balances.
[ 33%]
Cash1 to Assets
CashTotal Assets
Maintain minimum cash equal to [5% to 10%] of Assets. a. Higher PAR requires that the MFI increase its cash
reserves against client savings. b. b. For MFIs with decentralized funding, minimum
cash levels will need to be established at the branches also.
[ 5% - 10%]
Investment - Amount: In general, limit total investments to 10% of total assets.
[ 10%]
Individual Saving Client - No one savings client should account for more than (20%) of total savings.
[ 20%]
One branch Saving - No one branch should account for more than 50% of savings (unless in pilot stage of introducing savings).
[ 50%]
LIQUIDITY
Liquidity Reserves Legal Reserves. For MFIs that mobilize deposits, cash deposits (legal reserves) held at the Central Bank are
[ 25%]
1 CASH= 1 month’s operating expenses + one month’s net portfolio growth (loan disbursements less collections). For those MFIs beginning to mobilize savings, higher liquidity is recommended−up to 20% of assets in cash.
22
required. 1. Liquidity Reserves. As a general rule of thumb,
maintain a reserve of at least 10% of core savings deposits, while MFIs mobilizing larger institutional deposits are wise to have a 25% reserve.
Savings deposit reserve - 10 to 15% against savings deposits. [10% - 15%] Term or institutional deposits reserve
- 25% against term or institutional deposits (rate sensitive, thus more volatile).
[25%]
Liquidity ratio (NBC)
Cash and Bank Current accounts
Readily Marketable InvestmentTotal Asset
The detailed calculation is in appendix 2
The Liquidity Ratio indicates the institution’s ability to meet short-term liabilities and unforeseen expenses. An MFI may prefer to maintain a very high Liquidity Ratio (>25%) because it foresees high demand for its loans, or because it worries about inability. But high levels of liquidity can also indicate that an MFI is managing its funds poorly. A low Liquidity Ratio (<5%) often indicate that a MFI is managing its funding sources and is facing a cash crunch. It could also indicate that the institution has developed a sophisticated way of accurately predicting cash needs. A licensed deposit-taking microfinance institution shall at all times maintain a liquidity ratio of at least 50%.
[ 50%]
Branch Cash Management (Number of days in shipping cycle of cash plus 1 day safety margin) x (maximum daily net cash
outflow).
Branch Cash Management: maintain at branch on hand cash equal to (number of days in shipping cycle of cash plus 1 day safety margin) x (maximum daily net cash outflow).
[ X% ]
23
Credit/treasury lines - Diversification: Secure credit/treasury lines from a minimum of [3 to 5] banks to avoid too much reliance on a single funding source.
[ 3 to 5]
LIABILITIES AND EQUITY
DEBT TO EQUITY
LiabilitiesEquity
Debt/Equity, a common measurement of an MFI’s capital adequacy, indicates the safety cushion the institution has to absorb losses before creditors are at risk. It also shows how well the MFI is able to leverage its Equity to increase assets through borrowing and is frequently called the Leverage ratio. Maximum Leverage: Limit Debt to Equity to no greater than 6X (prudent level when considering 15% Basel risk capital requirements)
[ 6X]
Net Worth
Total Assets - Total Liabilities
For a company, total assets minus total liabilities. Net worth is an important determinant of the value of a company, considering it is composed primarily of all the money that has been invested since its inception, as well as the retained earnings for the duration of its operation. Net worth can be used to determine creditworthiness because it gives a snapshot of the company's investment history. also called owner's equity, shareholders' equity, or net assets. For example, if a company has $45 million worth of liabilities and $65 million in assets, the company's net worth (shareholders' equity) is $20 million ($65 million - $45 million).
- Individual client for n saving and fixed deposit [ 3%] of Net Worth
- Individual client for a group related clients for n saving and fixed deposit
24
The detailed calculation is in appendix 2 The net worth as calculated above shall be taken into account in calculating prudential ratios and other ratios. Those ratios include CAR and NOP.
[ 3%] of Net Worth
Capital Adequacy Ratio (CAR)
EquityTotal Risk Wieghted Asset
The detailed calculation is in appendix 2
Capital Adequacy Ratio (CAR) measures an institution’s solvency. The indicator provides information about ability to meet long-term expenses and obligations as well as absorb unanticipated future commitments. CAR measures an institution’s resiliency against both expected and unexpected losses, which may result from endogenous and exogenous causes. Higher CARs generally signify more capital, meaning an institution is better positioned to meet financial obligations and address unexpected losses. Riskier assets require the institution to hold higher capital reserves, including those as a factor to provide more precise solvency than a simple liquid ratio, in which current assets are compared with current liabilities. National bank of Cambodia required A licensed MFI shall maintain a capital adequacy ratio (CAR) of at least 15 percent between eligible capital which it includes core capital and hybrid capital instruments and its weighted risks.
[ 15%]
Net Open Position
Total Foreign Currency Assets - Total Foreign Currency Liabilities The detailed calculation is in appendix 2
A positive result indicates an overbought position (+) and a negative result an oversold position (-). The "Others" entry for currencies not individually specified should be divided to show the total for those currencies with net long positions and the total
[ 20 20%]
25
for those with net short positions.
Debt Service Capacity Operating Cash Flow
Debt Service next year Debt Service Capacity: A minimum debt service ratio of 1.2X will be maintained at all times. Debt Service= Operating Cash Flow/ Debt Service (next year)
[1.2 X]
COST OF FUNDS Interest and Fee Expenses
on Funding LiabilitiesAverage Funding Liabilities
As its name indicates, this ratio measures the average cost of the company’s borrowed funds. In comparing MFIs, the cost of funds ratio shows whether they have gained access to low cost funding sources such as savings. MFIs that can mobilize savings tend to have relatively low cost of funds. However this advantage is offset to some extent by the higher administrative cost of mobilizing savings. As subsidized MFIs grow, and as they increasingly resort to commercial borrowing to sustain their growth, rapidly rising cost of funds can lead to severe pressure on margins, which management must counteract by cutting other costs or raising lending rates. Perform a COF analysis on all debt annually to assure competitiveness, MFI profitability, and pro-forma leverage.
[X%]
Individual lender/investor
-
Debt relationships will be managed so that no individual lender/investor represents more than 30% of total funding. MFIs should also be careful not to rely too heavily on international funding, in case such sources become inaccessible during a crisis.
[ 30%]
Debt maturities in the next - Maturity: Limit debt maturities in the next year to no [ 20%]
26
year more than 20% of total debt (liquidity).
Dividends -
Dividends: No more than 30% of annual earnings will be distributed in any one year, unless approved by supermajority board approval. Dividends will be withheld whenever there is an anticipated loss in earnings for the following year.
[ 30%]
Note: This Suggest Financial Risk Appetite/Threshold is largely derived from Schneider-Moretto, Louise. 2005. Tool for Developing a Financial Risk Management Policy. New York: Women’s World Banking. http://www.swwb.org/toolkit-fordeveloping-a-financial-risk-management-policy. And the parameters listed in brackets (“[…]”), organization could change and set according to the real practice of business.
27
CHAPTER III
RESEARCH DESIGN AND PLANNING
3.1. Research Framework
Obj 1: To realize the significance of managing financial risk to CREDIT
Obj 2: To describe the real practice of Financial Risk management in CREDIT
Obj 3: To find out the limitation of Financial Risk Management in CREDIT
Literature Review
Topic: Financial Risk Management of CREDIT
Term Definitions Financial Risk Management Theory
Data Collection
Realize the significance of financial risk management to CREDIT.
Describe the real practice in financial risk management in CREDIT.
Findings out the limitation in financial risk management in CREDIT.
Conclusion and Recommendation
Data presentation and analysis
28
3.2. Research Methodology
Data collection bases on both the secondary and primary data in which the secondary
data includes information from draft risk management policy in 2011, accounting policy in
2010, treasury policy in 2010, and financial statement for period 2009-2010, ALCO reports
for March 2011 and independent auditor report for CREDIT in 2010. Primary data includes
information gathered through interviewing with Chief Finance Officer and Risk and
Compliance Unit Manager.
3.2.1. Research Design
This research is a qualitative designed and cross sectional study. It explored the
practice and of experience finance risk management of management and staff at CREDIT.
3.2.2. Data Collection
As mentioned above, there are two types of significant data, primary data and
secondary data used for this research.
Primary data is collected through the use of questionnaires as in appendix 1 to
interview directly Chief Finance Officer (CFO) and Risk and Compliance Unit Manager
(RCUM), in Finance Department and in Risk Unit to find out the information needed to
answer the three basic objectives of the research. The questionnaires were sent to the target
people in advance, and then, the researcher made appointment to meet them one by one to
discuss based on the questionnaires to collect the information to respond the objectives 1, 2 and 3
(significance of financial risk management to CREDIT, real practice of financial risk
management, and the limitation in financial risk management).
Secondary data, the researcher used existing documents within the company such as
draft Risk Management Policy in 2011, Finance Policy in 2010, Treasury policy in 2010,
29
financial statement for period 2009-2010, ALCO reports for March 2011 and independent
auditor report for CREDIT in 2010 to review reliable information regarding with those three
objectives and also to clarify the accuracy of all data getting from the previous staff interview.
3.2.3. Data Analysis
For the objective 2 (the real practice of Financial Risk management in CREDIT)
presented in this research is a qualitative study and data analysis is situational analysis based
on the data collection from the above section. This research study describes the real practices
and experiences in implementing financial risk management in the daily financial activities
within CREDIT.
For the objectives 1 (the significance of managing financial risk to CREDIT) and 3
(limitation of Financial Risk Management in CREDIT), researcher employs the process
analysis to discuss and explain the significance and limitation in financial risk management in
CREDIT.
Also, the researcher analyzes data based on ALM tables analysis, financial ratio
formula, and other useful risk parameters an accompanying by using Ms. Word & Excel for
table and ratio formula design.
3.3. Organization of the study
This research study is divided into 5 important Chapters as the followings:
Chapter I is the introduction to the research in which there are 4 more sections are
described. Section 1 is about the background and the rational of the study, section 2 is about
the problem statement and objectives of the research, section 3 is shown the scope and
limitation of the research and section 4 is described the significance of the study of this topic.
Chapter II is about the literature review about some important theories related to the
topic. The main literature review cover term definitions and financial risk management theory
30
which includes benefit of financial risk management, types of financial risks, and tools of
financial risk management.
Chapter III, design and planning of the study, is also divided into 3 sections. Section 1
is the research framework that explained the logical flow of work and concept of the research
study to produce or answer to the research objectives step by step from beginning until the
end of the research. Section 2 is the research methodology which explains the research design,
data characteristics are need to be collected and data analysis to reply or answer to the
research questions or research objectives. In this section 2, the 3 sub-sections are included:
sub-section 1, plan research design; sub-section 2, data collection; and sub-section 3, data
analysis. And section 3 is the organization of study which describes the structure or
organization of the repost for the whole research.
Chapter IV is data presentation and analysis. After the collection of the information
(primary data and secondary data) from the organization, the researcher has to describe, explain
and analysis the information to reflect to the research objectives and research questions in Chapter
I.
Chapter V is the conclusion and recommendation. There are two sections in this
chapter. Firstly, conclusion is a summary of the main point from the data presentation and
analysis in chapter IV to answer or reply to the research objectives. Secondly,
recommendation−it is the final part of the research paper− the researcher has to give the
specific and feasible recommendations to the company based on the finding in data
presentation and analysis to improve the weaknesses or to be effectiveness and efficiency of
financial risk management of the company in the future.
.
31
CHAPTER IV
DATA PRESENTATION AND ANALYSIS
4.1. Introduction to Financial risk and the important of financial risk management
The main business activities of CREDIT are financial products such as loan products,
saving products, and money transfer products. Ideally, it’s very important. Each risk can make
the business loss in terms of profits. Therefore, financial risk management is closely
monitored by treasury unit. To manage and mitigate the various risks in it business activities,
CREDIT has established and put in place the appropriate internal controls such as policies,
procedures, job descriptions, committees, etc.
Besides concentrating on credit risk and operation risk, CREDIT’s management also
give the importance to financial risk management as well. According to what mentioned by
CFO and RCUM, it realized the significance of financial risk management as following:
- Help the management pre-estimate the cash need or financial projection effectively
which can prevent the CREDIT from short fall of financial source for its operation and
liquidity crisis.
o Collect and analyze data on aggregate deposit balances by product type:
This analysis, plus senior management experience in marketing and managing
the deposit product, will help the CREDIT determine what percentage of
savings deposits is likely to be withdrawn on any given day (with the
remainder to be considered long-term or core deposits). It will also help the
CREDIT have an idea of what percentage of time deposits are withdrawn at or
before maturity versus those that are rolled over. This analysis will then inform
assumptions about savings and time deposits when measuring liquidity risk
and interest rate risk in asset and liability matching tables.
32
o Price savings correctly: Most customers for savings deposits are happy to
have a safe, reliable, secure, and convenient place to store savings and will not
demand high interest rates as long as they can easily withdraw savings as
needed. Time depositors behave differently than savings depositors. They are
typically storing excess liquidity for a set amount of time until they need it for
another use. Because they don’t have access to those savings during the time
period of the deposit, they look to the rate of interest paid (they are “interest
rate sensitive”). For both products, the CREDIT has considered profitability
not by product, but on an overall portfolio basis: How do savings affect the
CREDIT’s average costs of funds and, therefore, net interest income? It is also
useful to look at profitability on a client basis rather than a product basis—you
may lose money on providing a savings product to a client but gain money
from other products and services used by that same client.
o Design appropriate products. What is true for client loan products is also
true for savings products—creating a product that meets client demands is
important for attracting and retaining customers. However, the CREDIT must
balance client demands with its own need for stable and inexpensive funding
sources. CREDIT may need to offer both savings and time deposits to attract
customers. Financial expenses (e.g., interest paid) on those deposits can be
offset by fees charged for opening accounts or for those accounts that fall
below a minimum balance (this is also a technique for liquidity management).
Product design is key to managing the potential liquidity and interest rate risk
generated by deposits, and it is important in the overall pricing of the product.
33
- Help management team to identify and put in place the effective controls for managing
financial risks in form of establishing appropriate risk management, accounting,
treasury policies; developing the asset/liability mismatch tables; creating ALCO
committees; and other control tools for well managing financial risk.
- Enabling management to create a strategy that accounts for a field with multiple
players. A business with a well composed financial risk management plan is able to
remain aggressive in the market within its own pre-determined risk and opportunity
scenarios. In other words, the business predicts what will most likely occur in the
financial market and develops a strategy to grow the company in spite of those risks.
- Help managers in deciding what level of risk are acceptable and set limits to maintain
asset and liability mismatch at an appropriate level given the organization’s risk
appetite and growth and profitability targets.
4.2. Practice of financial risk management in CREDIT
The real practice of financial risk management of CREDIT at Head Office is mainly
through financial statement with including some ratios that represent the financial risk for
CREDIT, Asset/liability management, ALCO committee, risk management policy and
Accounting and Treasury Policies, and other instruments.
4.2.1. Financial statements
Financial statements are prepared into three main statements such as profit and loss
statement, balance sheet, statement of cash flow. The financial statements are properly drawn
up and given a true and fair view of the financial position of the Company as at 31 December
2010 and of its financial performance and of its cash flows for the year ended. In preparing
these financial statements, CREDIT is required to:
34
- adopt appropriate accounting policies which are supported by reasonable and prudent
judgments and estimates and then apply them consistently;
- comply with Cambodian Accounting Standards and the guidelines of the National
Bank of Cambodia relating to preparation and presentation of financial statements or,
if there have been any departures in the interest of true and fair presentation, ensure
that these have been appropriately disclosed, explained and quantified in the financial
statements;
CREDIT MFI Profit and Loss Statement FOR THE YEAR ENDED
December 31, 2010 Year 2009 Year 2010Financial Revenue Interest and Fee Income 5,826,265 7,541,900 Recovery on Loans 4,379 20,245 Gain on Foreign Exchange 2,533 513,093 Gain on Disposals of Assets 5,327 14,226 Other Incomes 1,006 4,689 Total Financial Revenue 5,839,510 8,094,153 Financial Expense Interest Expense on Borrowings 1,511,992 2,183,341 Interest Expense on Deposits 47,461 37,170 Fee &Commission on Borrowings 26,134 45,937 Total Financial Expense 1,585,587 2,266,447 Gross Financial Margin 4,253,924 5,827,706 Provision Loan Losses 675,409 (130,469)Net Financial Margin 3,578,514 5,958,174 Operating Expenses Salaries 1,629,498 2,266,556 Staff Benefits 201,671 269,939 Personnel Expenses 175,436 228,751 Local Travel 29,250 40,302 Travel/International 3,044 4,162 Communications 29,587 49,888 Office Expense 275,386 416,053 Printing Expense - - Software/Equipment 60,873 64,674 Vehicle Expense 168,942 234,277
35
Maintenance/Repair 4,845 8,235 Professional Expenses 63,125 123,763 Rebates/Loan Participant Expenses 5,857 5,172 Promotion/Recruit 67,827 51,873 Loss on Foreign Exchange 208,691 428,430 Loss on Sale/Disposals of Assets - 591 Various Expenses 30,716 48,598 Depreciation Expenses 123,906 173,931 Amortization Expenses 24,106 22,178 Total Operating Expenses 3,102,759 4,437,372 Net Income Before Taxes and Donation 475,756 1,520,802 Income Tax Expense 143,894 411,319 Net Income Before Donation 331,862 1,109,483 Donation 201,353 324,793 Profit (Loss) 533,215 1,434,276
CREDIT MFI BALANCE SHEET
AS AT 31-Dec-10 Year 2009 Year 2010ASSETS Cash on Hand 215,645 438,059 Balance with NBC 79,935 186,763 Balance with Other Banks 1,443,929 2,098,671 Loan and Advance to Customers 22,372,833 32,756,086 (Less) Loan Loss Reserve (705,260) (482,041)Investment in Equity 42,442 39,114 A/R and Other Assets 598,706 794,821 Deferred Tax Asset 106,691 105,103 Property, Plant and Equipment 668,595 839,732 (Less) Acc Depreciation (329,562) (470,470)Intangible Assets 35,862 21,085 TOTAL ASSETS 24,529,816 36,326,923 LIABILITIES AND EQUITY LIABILTIES Customer's Deposits 608,939 803,388 Borrowings 17,190,281 26,634,619 Provisions for Employee Benefits 419,147 667,782 Current Tax Liabilities 172,401 372,573 Deferred Income 143,686 93,678 A/P and other liabilities 711,783 794,756
36
TOTAL LIABILITIES 19,246,238 29,366,796 EQUITY Paid up capital 750,000 2,805,300 Donated capital-Prev year 1,997,299 2,057,850 Donated capital-Current year 60,551 32,274 Capital Reserve 123,873 Retained Earnings 1,942,513 506,554 Profit-Current Year 533,215 1,434,276 TOTAL EQUITY 5,283,578 6,960,128 TOTAL LIABILITIES AND EQUITIES 24,529,816 36,326,923
CREDIT MFI Statement of cash flows
AS AT 31-Dec-10 Year 2009 Year 2010 Cash flows from Operating Activities Net income before tax 677,109 1,827,947 Adjustment for Provision Loan Losses (IS) 675,409 (130,469) Depreciation Expenses 123,906 173,931 Amortization Expenses 24,106 22,178 Add: Loss on Sale/Disposal Assets - 591 Less: Gain on Disposals of Assets (5,327) (14,226) Grants Income (201,353) (324,793) Cash flows Generate from operations 1,293,849 1,555,159 Working Capital Change? Decrease/(increase) Statutory Deposit 3,294 (103,652) Loan and Advance to Customers (3,363,512) (10,476,004) Other Receivable (227,056) (192,630) Increase/(decrease) Customer's Deposits (254,545) 194,449 Other Liabilities 378,307 342,849 Cash used in operations (2,169,662) (8,679,829) Grant Received during the year 264,693 310,909 Income tax paid (533,136) (425,975) Net cash used in operating activities (2,171,538) (8,581,908)Cash flows from investing Activities Purchase of Intangible Asset (12,624) (7,400) Purchase of PPE (191,000) (204,958) Proceeds from disposals 5,327 14,226 Net cash used in investing activities (198,297) (198,132)Cash flows from financing Activities
37
Proceeds from borrowings 7,310,995 18,382,744 Repayments of borrowings 4,105,759 8,971,751 Translation different on borrowings (33,345) Net cash generated from financing activities 3,205,236 9,444,338 Translation different in cash and cash equivalents (216,032) Net increase in cash and cash equivalents 835,401 880,331 Cash and cash equivalent at beginning of year 1,652,304 1,661,553 Cash and cash equivalent at end of year 1,661,553 2,541,884
Beside these three statements, CREDIT has others several statements and reports for
tracking the financial performance and managing financial risks. These reports and statements
include NBC Ratios, Deferred Grant, Loan Balance, Balance Sheet by Currency, Balance
Sheet by Area, Profit and Loss Statement by Area, Profit and Loss Statement monthly, Profit
and Loss Statement by month, Profit and Loss Statement by fund, Whole Budget, Financial
Data (CGAP), Performance Indicators, and Quarter Report.
4.2.2. Asset/liability management
CREDIT has never had the financial risk problem, even though, the asset/liability
management process was used in CREDIT to manage mismatch of assets and liability to
identify liquidity risk, interest rate risk, and foreign exchange risk through employ the
liquidity risk table, interest rate risk table, and foreign exchange risk table.
Liquidity risk table
Liquidity risk is the risk of the Company being unable to meet its payment obligations
associated with its financial liabilities when they fall due and to replace funds when they are
withdrawn. The consequence of this may be the failure to meet obligations to repay depositors
and fulfill commitments to lenders. While CREDIT obtains the MDI license, the liquidity is
major concerned risk, which can strongly affect the whole business and the rest seems to be
manageable within CREDIT. As usual, the company’s management monitors balance sheet
liquidity and manages the concentration and profile of debt maturities. Monitoring and
38
reporting take the form of the reviewing of the daily cash position and projections for the next
day, week and month, as these are key periods for liquidity management. Management
monitors the movement of the main depositors and lenders and projections of their
withdrawals. Starting from March 2011, CFO has developed the liquidity risk table for
matching the maturities of assets and liabilities to see what funding gaps exist and then using
that analysis to adjust maturities of assets and liabilities as necessary, plan for refinancing
needs, and plan for adequate liquidity reserves or cushions in case of emergency.
The liquidity risk table was pulled apart the balance sheet into time buckets, then assigning
each type of asset and liability to the time bucket that corresponds to its maturity as table
below:
39
CREDIT Microfinance Institution Table 5: Liquidity Risk (Maturity Risk)
Express in local currency
Formula Explanation <1 month 1-2 months 2-3 months 3-6 months 6-12 months 1-3 years 3-5 years >5 years No
Maturity Total
Assets Cash 3,111,638 3,111,638
Demand Deposit -
Term Deposit -
Investment 45,022 45,022
Loan Portfolio net 3,791,496 3,791,496 3,791,496 8,272,356 10,340,445 4,480,859 - - - 34,468,150
Fixed Assets 15,173 15,173 15,173 34,139 45,519 94,832 113,798 45,519 - 379,327 Other Assets 27,147 27,147 27,147 72,393 99,540 467,068 226,228 63,344 407,543 1,417,557
Total Assets sum of row 1-7 6,945,454 3,833,817 3,833,817 8,378,888 10,485,504 5,042,759 385,047 108,863 407,543 39,421,693
Liabilities
Demand and Saving Account 227,826 72,904 72,904 136,696 318,956 82,017 911,303
Term Deposit 25,000 113,978 92,832 231,810
Loans Payable 675,339 1,305,971 2,326,409 4,151,420 5,276,471 15,437,638 29,173,248
Other Liabilities 144,751 200,274 300,411 500,685 100,030 181,754 302,924 121,170 1,851,997
Total Liabilities sum of row 9-12 1,047,916 1,579,149 2,724,724 4,902,778 5,788,289 15,701,410 302,924 121,170 - 32,168,359
Total Equity 7,253,334 7,253,334
Total Liabilities and Equity row 13+ row 14 1,047,916 1,579,149 2,724,724 4,902,778 5,788,289 15,701,410 302,924 121,170 7,253,334 39,421,693 Assets-Liabilities Gap [A-(TL+E)] row 8- row 15 5,897,539 2,254,668 1,109,093 3,476,111 4,697,215 (10,658,651) 82,123 (12,307) (6,845,791) Assets-Liabilities Gap as % of Equity
row 17/total equity 81.3% 31.1% 15.3% 47.9% 64.8% -146.9% 1.1% -0.2% -94.4%
Cumulative Assets - Liability Gap
cumulative sum of row 16 5,897,539 8,152,207 9,261,299 12,737,410 17,434,625 6,775,974 6,858,097 6,845,791 (0)
Cumulative Assets - Liability Gap as % of Equity
Row 18/total equity 81.3% 112.4% 127.7% 175.6% 240.4% 93.4% 94.6% 94.4% 0.0%
40
The table 5: Liquidity Risk (Maturity Risk) shows the positive gap between assets-
liabilities for the whole year, then the accumulative assets-liabilities gap get higher than
100%. It means that CREDIT has enough financial assets to meet its liabilities repayment for
the whole year. Or it means that CREDIT has enough liquidity to its liabilities obligation.
Although, the figure from ALCO report for March 2011 indicated that CREDIT had the
liquidity ratio 491.44% in March 2011 while the National Bank of Cambodia requires
maintaining above 50%. This high liquidity ratio present that CREDIT did not used cash
effectively to generate more profitability for the exceeded cash or idle cash.
Interest Rate Risk table
Interest rate risk−a type of market risk− is the possibility of financial loss from
changes in market interest rates that would then change the value of assets and liabilities.
Interest rate risk is a critical treasury function, in which financial institutions need to match
the maturity schedules, spreads2 and risk profiles (lending at fixed rates and borrowing at
floating rates) of their funding sources (liabilities) to the terms of the loans they are funding
(assets). Before 1 January 2011, the CREDIT managing interest rate risk through spread
analysis and risk profile. In March 2011, CFO of CREDIT has established interest rate risk
table for measuring the relationship among an institution’s cost of funds, the rate it charges
clients on its loan products, and its profit (net interest income). The interest rate risk table 6
below indicates the effective interest rates at the balance sheet date and the periods in which
the financial instruments re-price or mature, whichever is earlier.
In the table 6 Interest Rate Risk (Repricing Risk): mostly the same as liquidity risk but
it was just added the sensitive assets and liabilities analysis. Most of borrowing funds are
2 The percentage difference between the interest rate charged on a bank loan and the lender’s cost of funds
41
fixed rate, a few loans in floating rate (approximately $4.6 millions). The CREDIT lending
activities also charge a fixed rate from clients.
42
CREDIT Microfinance Institution Table 6: Interest Rate Risk (Repricing Risk)
Express in local currency
Formula Explanation <1 month 1-2 months 2-3 months 3-6 months 6-12 months 1-3 years 3-5 years >5 years No Maturity Total
Assets Cash 3,111,638 - - - - - - - - 3,111,638 Demand Deposit - - - - - - - - - - Term Deposit - - - - - - - - - - Investment - - - - - - 45,022 - - 45,022 Loan Portfolio net 3,791,496 3,791,496 3,791,496 8,272,356 10,340,445 4,480,859 - - - 34,468,150 Fixed Assets 15,173 15,173 15,173 34,139 45,519 94,832 113,798 45,519 - 379,327 Other Assets 27,147 27,147 27,147 72,393 99,540 467,068 226,228 63,344 407,543 1,417,557 Total Assets 6,945,454 3,833,817 3,833,817 8,378,888 10,485,504 5,042,759 385,047 108,863 407,543 39,421,693
Liabilities Demand and Saving Account 227,826 72,904 72,904 136,696 318,956 82,017 - - - 911,303 Term Deposit - - 25,000 113,978 92,832 - - - - 231,810
Loans Payable 675,339 1,305,971 2,326,409 4,151,420 5,276,471 15,437,638 - - - 29,173,248 Other Liabilities 144,751 200,274 300,411 500,685 100,030 181,754 302,924 121,170 - 1,851,997 Total Liabilities 1,047,916 1,579,149 2,724,724 4,902,778 5,788,289 15,701,410 302,924 121,170 - 32,168,359 Total Equity - - - - - - - - 7,253,334 7,253,334 Total Liabilities and Equity 1,047,916 1,579,149 2,724,724 4,902,778 5,788,289 15,701,410 302,924 121,170 7,253,334 39,421,693 Assets-Liabilities Gap [A-(TL+E)] row 8- row 15 5,897,539 2,254,668 1,109,093 3,476,111 4,697,215 (10,658,651) 82,123 (12,307) (6,845,791)
Assets-Liabilities Gap as % of Equity row 17/total equity 40.7% 15.5% 7.6% 24.0% 32.4% -73.5% 0.6% -0.1% -47.2% Cumulative Assets - Liability Gap cumulative sum row 16 5,897,539 8,152,207 9,261,299 12,737,410 17,434,625 6,775,974 6,858,097 6,845,791 (0) Cumulative Assets - Liability Gap as % of Equity row 18/total equity 40.7% 56.2% 63.8% 87.8% 120.2% 46.7% 47.3% 47.2% 0.0% Sensitivities Analysis Impact of 1% increase in interest rate per tenor bucket Row 16* 1% 58,975 22,547 11,091 34,761 46,972 (106,587) 821 (123) (68,458) Impact of 1% decrease in interest rate per tenor bucket Row 16* -1% (58,975) (22,547) (11,091) (34,761) (46,972) 106,587 (821) 123 68,458 Impact of 1% increase in interest rate on cumulative gap 58,975 81,522 92,613 127,374 174,346 67,760 68,581 68,458 (0) Impact of 1% decrease in interest rate on cumulative gap (58,975) (81,522) (92,613) (127,374) (174,346) (67,760) (68,581) (68,458) 0
43
Foreign Exchange Risk
Foreign exchange risk−type of market risk− is the potential for loss of earnings or
capital resulting from fluctuation in currency values. CREDIT frequently experiences foreign
exchange risk when borrowing in USD and lending in KHR. To reduce FX risk, some
practices such as currency exchange rate swap or future contracts to “lock-in” a certain
exchange rate and borrowing fund in KHR need to be implemented. The Company operates in
Cambodia and transacts in US$ and Riel, and is exposed to currency risks, primarily with
respect to Riel. Foreign exchange risk arises from future commercial transactions and
recognized assets and liabilities denominated in a currency that is not the Company’s
functional currency. Management monitors its foreign exchange risk against functional
currencies through monitoring the foreign exchange risk by using the absorbed risk of 20% of
the net worth required by the Central Bank. Currently, the management maintains the
currency swap with ACLEDA Bank Plc. of US$ 1,725,000 in the fixed account to mitigate
the foreign exchange risk and it incurs additional cost of 6% per annum. However, the
Company does not hedge its foreign exchange risk exposure arising from future commercial
transactions and recognized assets and liabilities by using forward contracts.
The table 7 below summarizes the Company’s exposure to foreign currency exchange
rate risk at 31 March 2011. Net Open Position by currency [A-(TL+E)] to Equity, 0.6%, 21.6,
and -22.2% for KHR, USD and EURO currency respectively. Profitability impact of 10%
depreciation and appreciation are 0.1% to -0.1%, 2.2% to -2.2% and -2.2% to 2.2% for KHR,
USD, and EURO respectively. While the benchmark 10% for each currency and 25%
combined for all currency, but the NBC law required the NOP 20% for each currency.
Moreover, if looking the Independent auditor report 2010, it show that CREDIT was in
positive position in managing foreign exchange risk because foreign currency exposure of
44
CREDIT is just 10.98% while NBC limited not more than 20%. But through Covenant Report
in March 2011, CREDIT faces foreign exchange risk since NOP for KHR increase up to
25.07% which is not compliance with regulation from NBC. Anyway, this risk was not effect
to CREDIT because CREDIT has the reliable reasons for defending it. Those reasons were
KHR swap with ACLEDA for amount 1,200,000USD or 4,851,150,000KHR was not ended
and at the same time NBC approved the donated capital request to paid-up capital for
4,251,596,000KHR in March 2011 which caused asset in KHR currency exceeded and NOP
for KHR currency increases accordingly.
CREDIT Microfinance InstitutionTable 7: Foreign Currency Risk
All the amounts expressed in USD and hedge currency are excluded Formula Explanation EUR USD KHR Total USD base
Assets
Cash 2,880,266 231,372 3,111,638
Demand Deposit -
Term Deposit -
Investment 45,022 45,022
Loan Portfolio net 25,764,124 8,704,026 34,468,150
Fixed Assets 379,327 379,327
Other Assets 874,977 542,580 1,417,557
Total Assets 45,022 29,898,694 9,477,978 39,421,693
Liabilities
Demand and Saving Accounts 903,337 7,967 911,303
Term Deposit 231,461 349 231,810
Loans Payable 22,260,293 6,912,955 29,173,248
Other Liabilities 1,550,307 301,690 1,851,997
Total Liabilities - 24,945,398 7,222,961 32,168,359
Total Equity 3,385,134 3,868,200 7,253,334
Total Liabilities and Equity - 28,330,532 11,091,161 39,421,693
Net Open Position [A-(TL+E)] 45,022 1,568,161 (1,613,183) (0)
Absolute Value of NOP absolute of R16 45,022 1,568,161 1,613,183 0
Net Open Position as % Equity Row 16/total equity 0.6% 21.6% -22.2%
Aggregate Net FX Open Position as % Equity row 17/total equity 0.6% 21.6% 22.2%
Assets/Liabilities row8/row15 #DIV/0! 1.2 1.3
Sensitivities Analysis
Profitability Impact of 10% depreciation row 18*10% 0.1% 2.2% -2.2%
Profitability Impact of 10% Appreciation row 18* -10% -0.1% -2.2% 2.2%
45
4.2.3. Risk Management and other policies
Even though CREDIT doesn’t have the specific financial risk management policy, the
financial risk, operational risk, credit risk, and others risks were manage by risk management
policy. Also some financial risk and activities were managed through accounting policy, and
treasury policy, other reports.
Risk management policy: In draft risk management policy of CREDIT mentions
about financial risks−liquidity risk, interest rate risk, and foreign exchange rate
risk−as following:
Definition for financial risks
• Liquidity Risk: the potential risk/possibility that an institution will be
unable to meet its obligations as they come due and deposit withdrawals.
Liquidity Risk usually arises from management’s inability to adequately
anticipate and plan changes in funding sources and cash needs. Efficient
liquidity management maintains sufficient cash reserves on hand (to meet
withdrawal, contractual loan repayment, and disbursement demand)
while investing as much idle fund as possible to optimize earnings
(converting cash into loans or market investments in prudent manner). If
CREDIT fails to meet cash obligations on a timely and cost-efficient
manner due to poor liquidity risk management, the confidence of its fund
owners, depositors, clients and other stakeholders could be affected
negatively.
• Interest Rate Risk: the possibility of financial loss from changes in
market interest rates that would then change the value of assets and
liabilities. Interest rate risk is a critical treasury function, in which
46
financial institutions need to match the maturity schedules, spread3 and
risk profiles (lending at fixed rates and borrowing at floating rates) of
their funding sources (liabilities) to the terms of the loans they are
funding (assets).
• Foreign Exchange Risk: the potential for loss of earnings or capital
resulting from fluctuation in currency values. CREDIT frequently
experiences foreign exchange risk when borrowing in USD and lending
in KHR. To reduce FX risk, some practices such as currency exchange
rate swap or future contracts to “lock-in” a certain exchange rate and
borrowing fund in KHR need to be implemented.
Approach to assess financial risks: Financial risks are assessed through 4
different steps.
Step 1: Risks identification− the happened and expected risks (residual
risks) under their responsibilities and operation area are allowed to raise in
risk workshop conducted by risk and compliance unit.
Step 2: Likelihood and Impact Scoring: The impact estimates are based on
imagined scenarios of what “might happen” and likelihood estimates are
based on historical information (recommended for document supported). The
descriptors of likelihood and impact are in appendix 3.
Step 3: Rating/ measuring risk: Risk is rated/ measured in terms of
likelihood and impact i.e. the likelihood of an event occurring combined with
its impact (consequence). Having established the likelihood and impact
scores, the scores should be plotted on the Risk Rating Map to determine the
3 The percentage difference between the interest rate charged on a bank loan and the lender’s cost of funds
47
rating of the risk being assessed in terms of a color and a represent letter for
the risk (e.g. a moderate impact 3 and possible likelihood 3 will result in a
rating of a yellow 9 in grade of Medium risk level). The Risk Rating Map is
in appendix 3.
Step 4: Registering identified risk into Risk Management Matrix: after
was rated/ measured, those risks need to be registered into Risk Management
Matrix as in appendix 3.
Reporting the financial risks is not different from the way reporting the credit
risk, operational risk and other risk. The financial risks are reported in form of
early warning report, risk management matrix, and summary report. Also
ALCO committee’s report is part of financial risk reporting.
• Early Warning Report: All departments Manager except audit are
required to develop the department’s individual early warning report in
line with the objectives and responsibility of each department. Risk
thresholds of each department are set as standard in the Early Warning
Report. Respective risk manager needs to highlight the identified risks
with appropriate color for alerting management on the level of risk.
Please find the Early Warning report in Appendix 2- Early Warning
Report. The reports are required to be sent monthly to RCUM and the
RCUM to consolidate the reports and send it to CEO and Senior
Management on monthly basis.
• Risk Management Matrix: To manage the existing and emerging risks
effectively, CREDIT has developed Risk Management Matrix for
consolidating all foreseeable areas of risk of all relevant departments
48
within CREDIT. The matrix includes: Area of Risk, Current Risk
Description, Risk rating with existing controls, Risk Trend, Additional
Actions/ Mitigation Strategies, and Estimated Risk level following
additional actions. Please refer to Appendix 2 for Risk Management
Matrix.
• Summary report: Basing the level of risk in the Risk Rating Map and
Risk Management Matrix, RCUM identifies items with high and medium
risks and brings the Summary to RMC meetings for review and
shortlisting of significant and emerging risks. Then RCUM will select the
Top 10 significant risks to present to Board of Director for
recommendation and further actions and in Senior Management and
Excom meetings.
Risk threshold for financial risk indicators: Even though CREDIT has not
established risk thresholds for all kind of risks, there are some financial risk
indicators were limited by National Bank of Cambodia (NBC) with ongoing
monitoring from CFO and senior management to avoid in breaching the
limitation set by NBC. Those risk indicators included in table 8
Table 8: risk indicators required by NBC
Indicators Limited Level
Actual level 31-Dec-10 31-Mar-11
CAR 15% 20.31% 17.71% NOP-USD
20%: -20%]
- 10.98% 24.44% NOP-KHR 10.41% -25.07% NOP-EUR 0.57% 0.63% Debt to equity 5.6% 4.22% 4.43% Liquidity ratio 50% 2340.47% 491.44% Reserve requirement ratio 8% 8% 8%
49
ALCO committee responsibility, structure, meeting and report as mentioned
in point 4.2.3.
Accounting policy: Besides accounting activities, the accounting policy of
CREDIT also mentions about financial risk management as following:
Capital Requirement and Reserve Requirement Accounts with NBC.
Liquidity Ratio and Capital Adequacy Ratio (CAR).
Treasury policy: In treasury policy of CREDIT, mostly cover the financial risk
management and activities involving financial risk management as following:
Liquidity Management: Cash reserve, Cash Projection, Liquidity Ratio by
NBC.
Financial Risk Management: Interest Rate Swap, Hedging Currency, Net
Open Position, Money Exchange, Assets Matching.
Yield Management: Idle Cash, Spread, alternative investment
4.2.4. ALCO committee
ALCO committee in management level was created in 31- Jan-2011 by Broad with the
purpose to drive the strategy and evolution of the institution in terms of assets and liabilities
structure, mitigating financial risks (liquidity risk, interest rate risk, and foreign exchange
(FX) risk,) while managing capital adequacy in the best interest of the institution and its
shareholders. ALCO committee is the primary decision making body related to various
aspects of financial risk management particularly liquidity risk, interest rate risk, and
exchange rate risk. A close review on the balance sheet needs to be made to identify, measure,
and manage the financial risks that arise from mismatches in asset and liability currencies,
debt maturities and fund re-pricing during the committee’s meeting.
50
The Committee chaired by Chief Finance Officer and its members include Chief
Executive Officer (CEO), Chief Operational Officer (COO), Internal Audit Manager (IAM),
Treasury Unit Manager (TUM), and Risk Manager (RM) and meet quarterly. In the meeting
in March 2011, ALCO committee discussed and reported on the following topics:
- Financial Covenant: it was presented about conditions required by lenders and current
performances of CREDIT whether those performances are compliant with the lenders’
requirements. (Financial Covenant report form is in appendix 4)
- Balance Sheet and Profit and Loss Evolution: they are presented the key accounts and
indicators which include cash on hand, PPE, interest income, financial cost, operating
expenses, etc and also include interest spread analysis.
- Budget Variance Analysis: it is presented the variances between planed items and
actual ones.
- 6-month Cash Flow Projection: it is presented the source of fund and use of fund for
period of upward 6 months.
- Financial and Risk Analysis: it is presented the liquidity risk, interest rate risk, foreign
currency exchange risk in form of AML tables as described in point 4.2.2.
In addition, ALCO minute is documented the discussion, agreements, and action plans
in the whole meeting.
4.2.5. Other instruments
Beside the risk management tools mentioned above, also, CREDIT managed the
financial risks through credit line with other local banks, currency swap with ACLEDA, while
management decided to accept interest rate risk because there is no available tool (interest risk
hedging) in Cambodia.
51
4.3. Limitation in financial risk management in CREDIT
The financial risk management is important for CREDIT in managing its financial
asset and liability in term of interest rate risk, liquidity risk and foreign exchange risk. Even
though, there are some limitations in financial risk management in CREDIT as following:
- Limited risk management resource: The risk management is the new work of CREDIT
and assigned staff−risk unit manager− did not have enough capacity to employ the full
role of risk management in CREDIT. With this new work, risk unit manager needs
much training, searching, and gradually learning from implementing risk management
function step by step.
- Limited risk management concept of senior management: The management of
CREDIT much experience in business operations but has not yet familiar enough with
the risk management and they are very new for financial risk management context
which is obstacle for them in outlining strategies for risk management especially
financial risk.
- Poor concept of staff in risk management: In fact the all operation staff have less
background in risk management which is the obstacle for implementing or rollout risk
management in their responsibilities. Also, it difficult to get them involve in
implementing the risk management.
- Add more burdens for staff: when the risk management introduces in CREDIT, all
staff must be involved and responsibilities for risk management works in their work
place and make their work more complicate and bigger−sometime some staff feel
bored and cause their work performance low.
- Too many controls: In the process that add the risk management function,
systematically required the adding more controls which cause the process slower than
52
before putting risk management in place and sometime affect the competition in
market due to products was not flexible and services too slow.
- Cost increase: some operation cost increase in responding to adding more staff,
processes, and control materials or mechanism.
53
CHAPTER V
CONCLUSION AND RECOMMENDATION
5.1. Conclusion
Based on the finding and this research paper by comparing with literature review,
therefore it reaches the conclusion as below:
CREDIT management has acknowledged the importance of financial risk
management which contributed to CREDIT operation as Microfinance
institution. Those significances are:
o Helping the management pre-estimate the cash need or financial
projection effectively which can prevent the CREDIT from short fall of
financial sources for its operation and liquidity crisis such as collecting
and analyzing data on aggregate deposit balances by product type,
pricing savings correctly and designing appropriate products.
o Help management team to identify and put in place the effective
controls for managing financial risks.
o Enabling management to create a strategy that accounts for a field with
multiple players.
o Help managers in deciding what level of risk are acceptable and set
limits to maintain asset and liability mismatch at an appropriate level
given the organization’s risk appetite which balance between risk and
growth or profitability targets.
The practice of financial risk management in CREDIT is in small size but it is
in best fit to its current operational size. The real practice of financial risk
management of CREDIT at Head Office is mainly through financial statement
54
with including some ratios that represent the financial risks for CREDIT,
Asset/liability management tables, ALCO committee, risk management policy,
accounting and treasury Policies, and other instruments. Although, CREDIT
did not have the separate financial risk management policy which detailed
about several financial risk indicators with setting risk accepted levels.
The limitations in implementing the financial risk management in CREDIT
include:
o Limited risk management resource
o Limited risk management concept of senior management
o Poor concept of staff in risk management
o Add more burdens for staff
o Too many controls
o Cost increase
5.2. Recommendation
According to researching on topic of Financial Risk Management of CREIDT, there
are recommendations to CREDIT as below:
CREDIT should establish the separate financial risk management policy
which much more entails risk indicators with accepted level of each risk.
In the context of separate financial risk management policy is not in place,
CREDIT should set up the risk threshold for its financial activities and
assigned the CEO, Treasury Unit Manager and RCUM to keep ongoing
monitoring.
CREDIT should build the staff capacity in subject of risk management and
financial risk management through attending various training in related fields.
55
CREDIT should seek more the advice from external consultant on its current
practices of financial risk management which not only would enable CREDIT
to fulfill the incompletion or inappropriate practices but also would keep
updating its financial risk management practices.
In order to implement financial risk management effectively, CREDIT
management should strongly support the risk management function and
actively participate in building risk management cultures in entire CREDIT.
56
REFERENCES
1. Louise Schneider-Moretto, Tool for Developing a Financial Risk Management
Policy, Women’s World Banking, 2005
2. A Risk Management Framework for Microfinance Institutions, Deutsche
Gesellschaft für Technische Zusammenarbeit (GTZ) GmbH, July 2000.
3. Bald, Joachim, Liquidity Management: A Toolkit for Microfinance
Institutions, Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ)
mbH, January 2000
4. Pocket Guide to the Microfinance Financial Reporting Standards Measuring
Financial Performance of Microfinance Institutions, The SEEP Network,
October 2010
5. Microfinance Financial Reporting Standards: Measuring Financial
Performance of Microfinance Institutions, the SEEP Network, draft October
2010, an Update (2nd Edition),
6. Karla Brom, Asset and Liability Management for Deposit-Taking
Microfinance Institutions, CGAP, June 2009
7. Frank Abate and Tor Jansson, Performance Indecators for Microfinance
Institutions, MicroRate and Inter-American Development Bank, available from
www.iadb.org/sds/msm and www.microrate.com.
8. Asian Development Bank, Risk management and Asset and Liability
Management in Bank (http://www.adb.org), Technical Assistance Consultant’s
Report, sited 02 Jul-11, available from
http://www.adb.org/documents/reports/consultant/42096-reg/42096-reg-
tacr.pdf
57
9. (http://www.investorwords.com/7890/financial_risk_management.html#ixzz1L
rJPM1y5), sited 18-05-2011: 11:58am
10. http://media.wiley.com/product_data/excerpt/67/04717061/0471706167.pdf,
sited 18-05-2011, 11:58am
11. http://bom.intnet.mu/pdf/Legislation_Guidelines_Compliance/Guidelines/Guid
elines%20-%20forex.pdf 07-07-2011, 5:30am
12. http://www.businessdictionary.com/definition/financial-covenants.html, sited
02-07-11, 6:20pm
13. Draft Risk management policy and risk assessment guideline, May 2011
14. Accounting and Treasury policies, 2010
15. Financial statement of CREDIT as 31 Dec 2010
16. ALCO meeting reports 28 April 2011
17. Independent report 2010
18. NBC Prakas on The calculation of Microfinance Institutions’ Net Worth
(August 27, 2007), Licensing of Microfinance Deposit Taking Institutions
(December 13, 2007), and the Internal Control of Bank and Financial
Institutions (September 28, 2010).
19. www.credit.com.kh
58
APPENDIX
Appendix 1: Research Questionnaires
Primary data
1. Questionnaire for Research objective 1: Importance of Financial Risk Management
to CREDIT. (ask to CFO)
Q1: What have financial risks incurred in CREDIT? How have they affected to
CREDIT?
Q2: What have CREDIT learn from the experiences of financial risk?
Q3: How important of financial risk management to CREDIT?
2. Questionnaire for Research objective 2: Real practice of financial risk management
in CREDIT (ask CFO).
Q1: What is general practice for managing financial risk?
Q2: What other additional tools you use for managing financial risk?
Q2: Who’s responsible for reporting and managing financial risk?
3. Questionnaires for research objective 3: Limitation of financial risk management
(ask CFO, and RCUM).
Q1: Can you describe the burden and limitation in financial risk management?
Q2: What burden to financial risk management to management and staff?
Q3: What is the weakness of financial risk management of CREDIT?
Q4: What are obstacles or challenge in financial risk management?
Secondary data
1. Questionnaire for Research objective 1: Importance of Financial Risk Management
to CREDIT.
Q1: Do financial activities of CREDIT consist of financial risks?
59
Answer: Yes No N/A
Q1: If yes, what kinds of financial risk would CREDIT face?
Answer:
Q3: Can the financial risks be managed or solved?
Answer: Yes No N/A
Q3: How important of financial risk management to CREDIT?
Answer:
Q4: Does CREDIT can operate its financial activities without Risk Management
function?
Answer: Yes No N/A
2. Questionnaire for research question 2: Real practice of financial risk management in
CREDIT.
Q1: Does the CREDIT use the Assets/Liability management to managing risk?
Answer: Yes No N/A
Q2: Does the CREDIT have the ALCO committee and risk committee?
Answer: Yes No N/A
Q3: Does ALCO committee meet and report regularly?
Answer: Yes No N/A
Q4: Does CREDIT have the risk management policy?
Answer: Yes No N/A
Q5: Is the risk management policy broadly mentioned about financial risk
management?
Answer: Yes No N/A
Q6: Are there other policies to cover financial risk management?
60
Answer: Yes No N/A
Q7: Are there risk register or risk management matrix in place for managing financial
risk?
Answer: Yes No N/A
Q8: Are there financial risk threshold in place?
Answer: Yes No N/A
Q9: What controls in place for mitigate financial risks in CREDIT?
Answer:
Q10: Does financial risk management tools of CREDIT enable to manage all financial
risks?
Answer: Yes No N/A
Q11: What tools to assess and measure financial risk in CREDIT?
Answer:
3. Questionnaires for research objective 3: The Limitation of financial risk
management.
Q1: Does financial risk management still limited in CREDIT?
Answer: Yes No N/A
61
Appendix 3: NBC Sample ratios calculation
1. LIQUIDITY RATIO KHR ‘000
i- Numerator: Liquid assets - Cash on hand xxxxx - Balances with the Central Bank xxxxx - Balances with banks xxxxx
Sub-Total (A) xxxxx
Less: - Amount owed to the Central Bank xxxxx - Amount owed to banks xxxxx
Sub-total (B) xxxxx
Net liquidity (A – B) xxxxxx
Plus: - Portion of loans outstanding maturing in less than one month xxxxxx
Liquid assets (L) xxxxxx
ii- Denominator: Adjusted amount of deposits (A) Category of deposits KHR ‘000 % - Voluntary savings xxxxxxxx 25% xxxxxx
LIQUIDITY RATIO (L/A) xxxxxxx
62
2. NET WORTH KHR ‘000 i- Sub-total A: Items to be added
- Capital or endowment xxx - Reserve, other than revaluation reserves xxx - Premium related to capital (share premium) xxx - Provision for general banking risks, with the prior agreement of the
Central Bank xxx - Retained earnings xxx - Audited net profit for the latest financial year xxx - Other items approved by the Central Bank xxx
xxx ii- Sub-total B: Items to be deducted
- For shareholders, directors, managers and their next of kin > Unpaid portion of capital xxx
> Advances, loans, security and the agreement of the persons Concerned as defined above xxx
- Holding of own shares at their book value xxx - Accumulated losses xxx - Formation expenses xxx - Losses determined on dates other than the end of the annual
accounting period (including provisions to be made for doubtful debt and securities) xxx
xxx iii- Total C: BASE NET WORTH = A – B xxx iv- Sub-total D: Items to be added
- Revaluation reserves, with the prior agreement of the Central Bank xxx - Subordinated debt, with the prior agreement of the Central Bank, up
to 100% of base net worth xxx - Other items, with the prior agreement of the Central Bank, could be
included in the calculation of net worth and shall not be more than the base net worth xxx
xxx v- Sub-total E: Items to be deducted
- Equity participation in banking and financial institutions xxx - Other items xxx
xxx vi- Total F: TOTAL NET WORTH = C + D – E xxx
63
3. SOLVENCY RATIO OR CAR
KHR ‘000 ii- Numerator (A)
Net worth xxxxxxx ii- Denominator (B) Assets (*) KHR ‘000 Weighting - Cash xxxx 0% - - Gold xxxx 0% - - Claims on the Central Bank xxxx 0% - - Assets collateralised by deposits xxxx 0% - - Claims on sovereigns rated AAA to AA- xxxx 0% - - Claims on sovereigns rated A+ to A- xxxx 0% xxxx - Claims on banks rated AAA to AA- - 20% - - Claims on sovereigns rated BBB to BBB- - 50% - - Claims on banks rated A+ to A- - 50% - - All other assets xxxx 100% xxxx
xxxx xxxx iii- Solvency ratio (A/B) xxxx% (*): The denominator of the ratio shall comprise the aggregate of the assets (net amount after deduction of provision and depreciation) and off-balance sheet items, weighted to their degree of risk. It excludes the items which are deducted in calculating the net worth according to the provisions of the Prakas on the calculation of microfinance institutions’ net worth. 4. NET OPEN POSITION IN FOREIGN CURRENCY Currency Assets
KHR ‘000Liabilities
and capitalKHR ‘000
Net openposition (NOP)
KHR ‘000
NOP/ Net worth
%
Limit
US$ xxx xxx xxx xxx% 20%KHR xxx xxx xxx xxx% 20%EUR xxx xxx xxx xxx% 20%Total xxx xxx - Net worth xxx
64
Appendix 3: Risk Assessment tools
Table-1: likelihood
Probability Indicators
1= Rare 0-20% chance of occurrence
It has not happened in the last 36 months and it is unlikely to occur.
2= Unlikely
21%-40% chance of occurrence
It has happened in the last 36 months, and it has happened more than
once, it may happen in the next 24 months.
3= Possible
41%-60% chance of occurrence
It has happened in the last 24 months, and it has happened at least
twice, it could happen in the next 24 months.
4= Likely
61%-80% chance of occurrence
It has happened in the last 18 months, and it has happened at more than
twice, it could happen in the next 12 months.
5= Almost Certain
>80% chance of occurrence
It has happened recently and it happens quite often, at least every few
months and will almost certainly happen in the next 12 months.
Table-2: Consequence
Consequence
Indicator
1
Insignificant
2
Minor
3
Moderate
4
Major
5
Catastrophic
Financial Single
Type of Lost-
USD per annum
0-7,500 >7,500-20,000 >20,000-$32,500 >32,500-45,0000 >45,000
Regulatory Minimal Impact Isolated
compliance
More isolated
compliance
Isolated serious
compliance issue
Systematic,
serious
compliance issue.
Informal
reprimand or
warning from
regulator.
Reputational
No media
coverage
increase in
customer
complaint
Increase customer
complain and
possible not
continuing to buy
our service
Increase customer
complain and some
clients not
continuing to buy
our service
More client not
continuing to buy
our service and
some media
coverage
Sustained Media
coverage, large
number of
customer lose and
significant effect
on sale price.
65
Business
Objectives
Achievement
Minor effect on
achieving
objectives
Isolated effect on
achieving
objective
Moderate effect on
achieving
objectives
Significant effect
on
achieving
objectives
Objectives will
not
be achieved
Service
Disruption
Minor service
disruption Service disruption
More service
disruption
Significant service
disruption
Total service
disruption
Stakeholder
Concern
Little or no
stakeholder
interest
Stakeholder
interest
No stakeholder
interest and
concerned
Stakeholder
concern
Stakeholder
intervention
Media Attention Little or no
Media attention
Some Local Media
attention
More Local Media
attention
National Media
attention
International
Media
attention
Injury Loss
No lost time or
compensatory
injury
Lost short time
(<2 week) due to
injury
Lost long time (>2
week) due to
injury
Disabling injury Fatality
Cost Variations Actual cost as
planned
Actual cost show
a <10% variance
Actual cost show a
variance of >10% -
20%
Actual cost show a
variance of >20% -
50%
Actual cost
exceeds
50% of planned
Risk Rating Map
Lik
elih
ood
5= Almost Certain M H H E E
4= Likely M M H H E
3=Possible L M M H H
2=Unlikely L L M M H
1= Rare L L L M H
Net Risk Exposure (Impact/Likelihood)
1 Insignificant
2 Minor
3 Moderate
4 Major
5 Catastrophic
Impact/consequence/Severity Legend:
Green L = Low Risk– manage by routine procedures Yellow M = Medium Risk– specify management responsibility Dark Orange H = High Risk– needs senior management attention Red E = Extreme risk – detailed action plan required
High or Extreme risks must be reported to Senior Management and require detailed
treatment plans to reduce the risk to Low or Medium.
66
Risk Management Matrix Key Risk Trend- Increase (I), Decrease (D), Stable (S) Risk Level- Extreme (E), High (H), Medium (M), Low (L)
No Area of
Risk
Current Risk Description
Risk Rating with existing controls
Ris
k Tr
end
I, D
, S
Risk Implication Additional Actions
Ris
k O
wne
r
Due Date
Estimated Risk level following additional
actions (E, H, M, L)
Like
lihoo
d 1,
2, 3
, 4, 5
Impa
ct
1, 2
, 3, 4
, 5
Ris
k Le
vel
L, M
, H, E
Note: 1. No: Code of risks
- Credit Risk = CR000xx - Interest Rate Risk = IRR000xx - Foreign Exchange Risk = FXR000xx - Liquidity Risk = LR000xx - Operation Risk = OPR000xx - Reputation Risk = RR000xx - Regulation and Compliance Risk = RCR000xx
2. Area of Risk: Risk type can be write in shortcut such as CR = Credit Risk, OPR = Operation Risk…….
3. Current Risk Description: Description can be written in short sentence as title/heading and brief description to support risk title.
4. Risk Analysis
- Likelihood: This is a re-assessment of how likely the risk is to occur now, after controls are in place and their effectiveness is considered. Rate 1 if the risk was rare to happen and rate 5 if the risk is frequently or most certain happened.
- Impact: This is assessment of how serious the impact now is, again, after the existing controls are considered. Rate 1 to 5. 1 if the impact is very small and 5 if the impact is very big.
- Risk Level = impact X Likelihood. The risk level can be scored following the risk level in Risk Rating Map.
5. Risk Trend: Such as Increase, stable or decrease 6. Risk Implication: Describes what happened and would happen if
the risk occurs. 7. Additional Actions: Additional action/ strategies to mitigated risk
would be mentioned. 8. Risk owner: the specific departments for relevant risks will be
assigned to control and monitor those risks. 9. Due date: Fill out the date when your action can be completed. 10. Estimated Risk level following additional actions: the estimation for
risk level can be score as lower or in the same level after you taken actions are accomplished.
67
Department:‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ Period:‐‐‐‐‐‐‐‐‐‐‐‐‐ Report date:‐‐‐‐‐‐‐‐‐‐‐‐
Early Warning Report Risk Indicator Warning Level Limit Level Actual Level EWS* 1
2
New risks raising
No Risk description Likelihood Impact Risk level
1 - Brief description of risk - Root cause
2 - Brief description of risk - Root cause
* EWS: Early Warning Status Safe ☺Warning Trigger
Note: This early warning report requires filling out in this form in soft copy and send by e‐mail to RCUM by not exceed the 2nd week of next month.
68
Appendix 4: Covenant Report form
Lender Advance Payment/Late Repayment Ratio Name Covenant
Requirements Current MFI Performance
Other Covenant Notes
XYZ
* For late repayment the overdue amount will be……..................
Portfolio at risk 30+ < xx% < xx% * Merger, Sale of Assets: …………………………. Write off Ratio < xx% < xx%
Leverage Ratio < x:y < x:y Unhedged foreign currency < xx% < xx% Solvency Ratio >xx% >xx%
ABC
* For late repayment the overdue amount will be……..................
Portfolio at risk 30+ < xx% < xx% * Merger, Sale of Assets: …………………………. Write off Ratio < xx% < xx%
Leverage Ratio < x:y < x:y Unhedged foreign currency < xx% < xx% Solvency Ratio >xx% >xx%
69
មលសេងខប េ យេមើលេឃើញកររកចេរ ើនរបសេរកឌត ជមយនងករេកើកេឡើងនវភពសមក ម ញ
េនកនងសកមមភពហរញញវតថខលន អនករ វរជវបនសេរចេធវើករសក រ វរជវ េលើរបធនបទ
សតអពកររគបរគង នភយហរញញវតថ។ កមមវតថ ៃនរបយករណរ វរជវេនះ គេដើមបយលដងព
រៈសខនៃនកររគបរគង នភយហរញញវតថ ពពណនពករអនវតតកររគបរគង នភយ
ហរញញវតថជកែសតង នងបងហ ញពែដនកណតៃនកររគបរគង នភយហរញញវតថ េនកនងេរកឌត
េ យែផអកេលើពតមនែដលបនមកពករសមភ សជមយរបធននយកហរញញវតថ នងរបធនែផនក
របតបតត នង នភយេន ែខ កកក ឆន ២០១១ ពរងងេគលនេយបយរគបរគង នភយ ឆន
២០១១ របយករណហរញញវតថចង ឆន ២០០៩ នង ២០១០ េគលនេយបយគណេនយយ
នងរតនភបល ឆន ២០១០ នងរបយករណរបសគណៈកមម ធកររគបរគងរទពយសកមម
នងរទពយអសកមម (ALCO) ស ប ែខ មន ឆន ២០១១។
េនកនងករសក រ វរជវេនះ អនករ វរជវបនេរបើរបសទនននយសខនៗពររបេភទ គ
ទនននយែដលមនរ ប នងទនននយេដើម។ ករសក រ វរជវេនះជរបេភទករសក ែបប
បរមណ នងករសក ែបបពពណន។ ចេពះកររបមលទនននយវញ អនករ វរជវបនេរបើករង
សណរេដើមបរបមលទនននយេដើម នងទនននយែដលមនរ ប េហើយករវភគទនននយរបសករ
រ វរជវេនះ គជករវភគែបបដេណើ រករ នង ថ នភព។
លទធផលៃនកររ វរជវបងហ ញថ រៈសខនៃនកររគបរគង នភយហរញញវតថចេពះ
េរកឌត មនដចជៈ ជយគណៈរគបរគងពយករណ ចរបកែដលរតវករ របនទកជមននវ
តរវករ ចរបកេ យមនរបសទធភព ជយគណៈរគបរគងកណត នង កេ យអនវតត
កររតតពនតយែដលមនរបសទធភពនន ស បរគបរគង នភយហរញញវតថ ចេ យគណៈ
រគបរគងេរៀបចយទធ រសតែដលទទលខសរតវចេពះវសយែដលមនរបតបតតករេរចើន ជយគណៈ
រគបរគងសេរចចតតកនងករកណតករត នភយែដល ចទទលយកបន នងករកណតករតៃន
ភពមនសគន រ ងរទពយសកមម នងរទពយអសកមម។ កនងករអនវតតនជកែសតង េរកឌតេរបើរបស
របយករណហរញញវតថ ែដលមនបញច លអនបតមយចននែដលបងហ ញនវ នភយហរញញវតថ
ងរគបរគងរទពយសកមម នងរទពយអសកមម គណៈកមម ធកររទពយសកមម នងរទពយអសកមម េគលន
េយបយរគបរគង នភយ េគលនេយបយគណេនយយ នងរតនភបល នងឧបករណ
ដៃទេទៀត។ កនងេនះផងែដរ កមនែដនកណតជេរចើនកនងករអនវតតនកររគបរគង នភយ
ហរញញវតថកនងេរកឌត ែដលរមមន ចេណះដងមនករតរបសគណៈរគបរគង នងរបធនែផនក
នភយ នងរបតបតត េលើកររគបរគង នភយហរញញវតថ ករយលដងរបសបគគលកអពកររគប
រគង នភយេនទប ករបែនថមបនទកករងរដលបគគលក កររតតពនតយេរចើនេពក នងករេកើន
េឡើងនវករច យ។
សរបមកកររគបរគង នភយហរញញវតថ របសេរកឌត មនទហតចេនេឡើយ ែតសកតសម
បផតេទនងទហរបតបតតកររបសេរកឌត។ េទះជយង កេ យ អនករ វរជវបនផតល
70
អន សនមយចនន េដើមបេ យកររគបរគង នភយហរញញវតថ របសេរកឌតកនែតរបេសើរ
េឡើង។ អន សនទងេនះមនដចជៈ ករបេងកើតេគលនេយបយរគបរគង នភយហរញញវតថមយ ចេ យែឡក ករបេងកើតករតទទលយកបនរបស នភយស បសកមមភពហរញញវតថទងេនះ ពរងងសមតថភពបគគលកេលើមខវជជ រគបរគង នភយ ជលអនកពេរគះេយបល
មកពខងេរកេ យជយ ករគរទយងេពញទហង នងករចលរមយងសកមមកនងករពរងង
វបបធមរគបរគង នភយពគណៈរគបរគង។
