Risk Management

Awareness of the risks that exist within the microcredit industry is an important first step towards planning for and mitigating them. This section will outline the three main risks that face Pi Slice lenders: entrepreneur risk, microfinance institution risk, and country risk; and discuss what steps Pi Slice has taken to mitigate the risk, and what Pi Slice lenders can do to reduce their exposure further.

Risk of Entrepreneur Default

Entrepreneurs may default on their loans for a number of reasons, ranging from personal or business problems, to political or environmental reasons. Most microfinance borrowers are unable to provide collateral for their loans, removing one of the main tools used by traditional financial institutions for mitigating credit risk.

Our partner microfinance institutions (MFIs) are experienced in providing credit to their communities, and conduct thorough assessments before approving any loan. These assessments will generally look at the prospective client’s character, business, their level of poverty, and their environment, as well as utilising the local community knowledge of the loan officers.

 Often MFIs prefer to structure their loans in the form of solidarity groups; sometimes simply for moral support, and other times a more formal group that agrees to guarantee the group payments in case one of the members defaults.

In general, the default rate in microfinance has historically been low, but past performance is not a reliable predictor of future trends. The global recession has undoubtedly affected micro-entrepreneurs to some extent, making it even more important that MFIs maintain rigorous processes for credit assessments.

What does it mean for Pi Slice members?

Pi Slice members are protected from entrepreneur default. We believe that it would be unfair to ask lenders on our website to take on the risk of an entrepreneur defaulting without access to information that would allow lenders to assess the risk fully.

Therefore we have an agreement with our partner MFIs, who have the experience and opportunity to do credit risk assessments on each client, that they will cover the cost of any borrower defaults that may occur.

Microfinance Institution Risk

Pi Slice partners with microfinance institutions (MFIs) in the countries we operate in. These partner organisations are responsible for assessing loan applications, disbursing loans to borrowers, posting loans on the Pi Slice website, and collecting repayments. They have the experience, expertise, and local knowledge necessary to perform this role to the highest standards.

However, as with all businesses, MFIs are exposed to many different risks, some of which could affect their ability to pay their liabilities to funders such as Pi Slice lenders. These include:

·       Bankruptcy – this could be caused by poor operational control, poor risk management, or external issues such as changes to the political or environmental context, or fluctuations in the financial markets.

·       Fraud – as with all businesses involving large amounts of money, fraud is a constant risk.

·       Portfolio risk – if a large number of borrowers default, for example as a result of a drought, the MFI may find itself unable to pay its debt obligations.

What does it mean for Pi Slice members?

Pi Slice takes great care in its selection of MFIs, and is dedicated to partnering only with strong and well-established institutions (for more information about how we choose our partners, see *How We Operate – insert link*). We have the following risk management processes in place to reduce the risk of MFI defaults:

·       Each MFI is subject to a thorough due diligence investigation, operational audit, and investment committee before it is accepted. We only consider MFIs that have been recommended by PlaNet Finance Group.

·       MFIs are reviewed on an ongoing basis to ensure that they remain within our criteria. Any relevant changes to their situation are assessed by Pi Slice and partner MicroWorld.

·       Pi Slice's partner MicroWorld and local correspondents in MFIs carry out regular checks and reconciliations to combat fraud and system errors.

Despite these measures, it is impossible to eliminate all risk. The possibility of one of our partner MFIs being unable to pay Pi Slice lenders back exists. Therefore we recommend that our members spread their loans across different MFIs and regions to reduce their risk of losing their loan portfolio.

Country Risk

As well as being aware of the entrepreneur and MFI risks, it is also important to understand the macro risks, which can affect an entire country, or in the case of the recent financial crisis, most of the world. Microfinance is a dynamic industry with interconnections to many other industries, as well as environmental and political exposures. The nature of the industry means it is often conducted in countries with histories of instability of some kind. Potential risks include:

·       Political risk – the government of the country may change laws or regulations related to microfinance, or decide to stop funds leaving the country. This has happened on several occasions in the past.

·       Economic risk – high inflation or the devaluation of the local currency may cause the MFI difficulty in meeting their financial obligations if they are from foreign sources.

·       Natural disasters – Events such as the South Asian Tsunami in 2005 or the floods in Pakistan in 2010 can have enormous effects on the microfinance industry, as they often affect the poorest people the worst.

What does it mean for Pi Slice members?

Pi Slice and partner MicroWorld evaluate country risk as part of their due diligence process, and will not accept MFIs from countries where the risk is deemed to be too high. The macro situation is monitored on a regular basis for signs of risk increases. Our partner MFIs have agreed to take on the foreign currency risk, as they are experienced in managing this.

In general, however, country risk is one of the least controllable risks. Pi Slice lenders are advised to diversify their loan portfolio across different countries and regions to reduce their exposure to any single country or region.