Better Asset and Liability Management: an urgent need

June 18, 2009    

The onset of the worst global financial crisis in decades has brought home to many financial institutions, and their clients, many of the fundamentals of finance that can be overlooked in times of rapid growth and surging income.

In the latest Focus Note from CGAP, "Asset and Liability Management for Deposit-Taking Microfinance Institutions", author Karla Brom argues that many Microfinance Institutions (MFIs) need to strengthen their asset and liability management to match the diversification of their funding sources and the risk that comes with it.

Many MFIs have evolved from relying on a combination of grants and concessional funding to commercial sources of finance, including deposits, loans, bond issuance and equity. Accordingly, these institutions need to place greater emphasis on liability management in particular. This need has become all the more urgent given the scarcity and higher cost of funds to MFIs during the global financial crisis.

“In the microfinance sector to date, asset and liability and financial risk management have not received the same attention as credit and operational risk management, largely because of the way the sector has developed, with MFIs focused on the development, delivery, and repayment of appropriate products for clients,” Brom says.

“Now the MFIs are accessing more diverse and commercial sources of funds, and more MFIs are transforming into regulated institutions with the ability to attract private equity and/or offer deposit products, asset and liability and financial risk management are increasingly important,” she says.

This CGAP publication recommends that MFI managers, as a first step, decide what level of risk is acceptable and set limits on their asset and liability mismatch at an appropriate level, taking into account their institution’s risk tolerance, and growth and profitability targets.

MFI managers need to be closely reviewing their balance sheets to identify, measure and manage the financial risks that stem from mismatches in asset and liability currencies, debt maturities, and funds re-pricing – in other words, foreign exchange, liquidity and interest rate risks.

Proper asset and liability management need not be overly complex. Tools include a simple set of asset and liability matching tables, a financial risk-management policy, and an asset and liability committee (ALCO). The key to sound asset and liability management is properly defining an organization’s risk appetite, clearly laying out the balance between meeting financial goals through greater exposure to forex, interest rate and liquidity volatility with the need to minimize risk.

MFIs then need to consider a realistic approach to implementing a sound asset and liability management system, taking into account the often scarce labor and financial resources available to them.

While seemingly a daunting challenge, Brom argues that better asset and liability management is within the scope of today’s MFIs, and that the global financial crisis will have brought home its importance of having sound systems in place well before crisis arrives.

MFIs that define their risk appetite and policy for managing it, combined with sound systems such as an asset and liability committee (ALCO), risk monitoring, and contingency planning will be far better prepared for the next inevitable financial shock.