Usury Report > 5. Risk weighting assessment

We have argued earlier that the risk of microfinance institutions can be divided into two sources, viz., systemic risk (the risk that the system transfers to the institution) and organisation specific risk (the risk originating from the clients or from inside the organisation). These risks are presented and assessed in the next tables. At this moment we are not quantifying the risks in detail. We have argued in section 4.7 how these risks can be quantified. In this table we wilt attach a value to each risk (in generic form).

Table 21: Risk estimate based on systemic risk

Risk and Functioning	Assessment	Estimated cost expressed as impact on income	Weighting / importance
Impact on Microfinance institutions due to impacts on the broad financial market	Medium but small impact due to cost structure of microfinance institutions	1 - 2%
General increase in wages, transport costs, etc	Medium to high	5 - 10 %
Market collapse because of over indebtedness	High	10 - 50 %
More unemployment, especially of government employees	High	10 - 20%
Segmentation of market cause risks - sharing of information	Medium	5 - 15 %

The estimated cost is provided as a range covering the different types of microfinance institutions, ranging from cash lenders, micro enterprise lenders to term lenders. We have estimated that newly 7 per cent of government employees on the PERSAL system are vulnerable in terms of over-indebtedness. We have provided several salary slips (see Annex 7) which indicate the severity of this debt trap of certain employees. This translates into nearly a one billion Rand potential loss (if we assume that provident funds or other collateral does not cover these diet) that wilt impact on the term-lenders specifically.

Table 22: Risk estimate based on organisational risk originating from outside the firm

Risk and Functioning	Assessment	Estimated cost expressed as impact on income	Weighting / importance
Client cannot provide security	Medium - reality of this market, have collateral substitutes	3 - 7%
Income risk - client cannot pay	Low, medium, high	5 - 7%
Income risk - client will not pay	Medium	2 - 3%
Policy & legislation risk	Low to medium	1 - 5%

Most clients in the microfinance market have scarce collateral. Until recently this was a severe problem as most financiers based their collateral estimates on conventional concepts of collateral, for example, fixed property. Innovative thinking in the microfinance sector led to the use of repayment ability, with assets like provident and pension funds serving as collateral. There are however still risks pertaining to collateral. Losing your job implies a severe impact on your repayment ability. Also, you put future consumption at risk when you use your provident fund to guarantee consumption loans (as example as this should not happen in the sector).

Policy and legislation risk refers to the changes to the sector that changes in legislation can initiate. A very good example is the growth of this industry based on the lifting of the Usury Act floor from zero to R6,000.

Table 23: Risk estimate based on organisational risk originating from inside the firm

Risk and Functioning	Assessment	Estimated cost expressed as impact on income	Weighting / importance
Technical risk - information technology	Medium to high	10 - 25%
Technical risk - financial technology	Medium to high	10 - 25%
Marketing risk - appropriateness of products	Medium	5 - 15%
Operational risk	Low to medium	5 - 15%
Price risk	Medium	5 -.15%
Human resource risk	Medium	10 -.15%
lnformation risk	High	10 - 30%

What about the risks the clients engage in when signing a loan contract?

Table 24: Risk estimate of clients entering into loans

Risk and Functioning	Assessment	Estimated cost expressed as impact on income	Weighting / importance
Lack of information - taking to high levels of loans and not understanding the implications of repayment	Serious problem	High

It will be incomplete if we do not provide an indication of the risk of the microfinance sector for the broader financial sector. In the next table this is presented.

Table 25: Risk estimate of the possible risks of the microfinance sector impacting on the broad financial sector

Risk and Functioning	Assessment	Estimated cost expressed as impact on income	Weighting / importance
Risk of collapse in microfinance market - consumer finance	Low to medium risk	Medium to high (not due to cost but to political backlash
market - enterprise finance	Medium	Setback for employment and job creation

Usury Act, 1968 (Act No. 73 of 1968)

Report on Costs and Interest Rates in the Small Loans Sector

5. Risk weighting assessment