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Defining Risk

A risk event can be defined as an uncertain event that may or may not occur in any given time period, resulting in financial consequences for an MFI. The financial consequences of the uncertain event may be fixed or may be unknown in advance. Risk management is about reducing the possibility of losses due to risk events, and optimising the 'upside' of risk, since most risks present opportunities of some form.

Common measures of risk include a measure of the frequency of the risk - is the risk event likely to happen once a day, or once every twenty years? - and a measure of the severity of the associated loss - if it happens, will we lose 1% of our profit, or 80%?

Risk can be managed in a number of ways:

  • Control: risk is controlled by:
    • reducing the likelihood of the risk event occurring, for example by providing clients with information on how to prevent HIV & AIDS ;
    • reducing the severity of the loss likely to result e.g. by ensuring that PLWHA clients know how to live positively and possibly access ART; and/or
    • reducing the uncertainty in the event's occurrence or the loss.

  • Retain/accept: risk is retained when no further action is taken and the possibility of the risk event's occurrence and consequent losses are accepted as a cost of doing business.

  • Avoid: certain risks can be avoided altogether for example by not entering a particular market, or not offering a certain type of product.

  • Transfer: risk may be transferred to another party. Insurance transfers Mortality risk to an insurer. Outsourcing transfers risk to an external provider.

For each risk, the risk level (likelihood and severity) in the absence of controls is called the inherent risk. The risk that remains after controls have been implemented is referred to as residual risk. The difference between the two is the controlled risk.

Case Studies

Box 2.1 Inherent and Residual Risk

Suppose that an MFI loses $1000 per year in bad debts due to client AIDS deaths, before attempting any risk management. This is the inherent risk.

Suppose the MFI partners with a local government antiretroviral programme and local AIDS service organisation providing education and VCT. As people access treatment, the deaths reduce, and the following year the losses are only $400. This is the residual risk.

The $600 that was saved by implementing the risk control is effectively the controlled risk.



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